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Is Magal Security Systems Ltd’s (NASDAQ:MAGS) PE Ratio A Signal To Sell For Investors?

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This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

Magal Security Systems Ltd (NASDAQ:MAGS) trades with a trailing P/E of 77.8, which is higher than the industry average of 27.1. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.

Check out our latest analysis for Magal Security Systems

What you need to know about the P/E ratio

NasdaqGM:MAGS PE PEG Gauge October 10th 18
NasdaqGM:MAGS PE PEG Gauge October 10th 18

P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.

P/E Calculation for MAGS

Price-Earnings Ratio = Price per share ÷ Earnings per share

MAGS Price-Earnings Ratio = $5.61 ÷ $0.0721 = 77.8x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 MAGS, 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. MAGS’s P/E of 77.8 is higher than its industry peers (27.1), which implies that each dollar of MAGS’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Electronic companies in US including Electro Scientific Industries, Surge Components and Evans & Sutherland Computer. You could think of it like this: the market is pricing MAGS as if it is a stronger company than the average of its industry group.

Assumptions to watch out for

Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to MAGS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Magal Security Systems Ltd is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with MAGS are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.

What this means for you:

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 MAGS. 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. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for MAGS’s future growth? Take a look at our free research report of analyst consensus for MAGS’s outlook.

  2. Past Track Record: Has MAGS been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of MAGS’s historicals for more clarity.

  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.