Is Hercules Capital Inc (NYSE:HTGC) A Buy At Its Current PE Ratio?
Hercules Capital Inc (NYSE:HTGC) trades with a trailing P/E of 12.7x, which is lower than the industry average of 15.7x. While this makes HTGC appear like a great stock to buy, 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 Hercules Capital
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 HTGC
Price-Earnings Ratio = Price per share ÷ Earnings per share
HTGC Price-Earnings Ratio = $12.1 ÷ $0.95 = 12.7x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as HTGC, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since HTGC’s P/E of 12.7x is lower than its industry peers (15.7x), it means that investors are paying less than they should for each dollar of HTGC’s earnings. As such, our analysis shows that HTGC represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that HTGC is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to HTGC. 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 HTGC, 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 HTGC to are fairly valued by the market. If this does not hold, there is a possibility that HTGC’s P/E is lower because our peer group is overvalued by the market.
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.
