Gilat Satellite Networks Ltd (NASDAQ:GILT) is trading with a trailing P/E of 51.8x, which is higher than the industry average of 21.2x. While this makes GILT appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Gilat Satellite Networks
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for GILT
Price-Earnings Ratio = Price per share ÷ Earnings per share
GILT Price-Earnings Ratio = $7.52 ÷ $0.145 = 51.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as GILT, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 51.8x, GILT’s P/E is higher than its industry peers (21.2x). This implies that investors are overvaluing each dollar of GILT’s earnings. As such, our analysis shows that GILT represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your GILT shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to GILT. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with GILT, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing GILT to are fairly valued by the market. If this does not hold true, GILT’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to GILT. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If GILT has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Gilat Satellite Networks for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.