MagnaChip Semiconductor Corporation (NYSE:MX) is currently trading at a trailing P/E of 3.8x, which is lower than the industry average of 24.7x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for MagnaChip Semiconductor
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 MX
Price-Earnings Ratio = Price per share ÷ Earnings per share
MX Price-Earnings Ratio = $9.5 ÷ $2.502 = 3.8x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MX, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since MX’s P/E of 3.8x is lower than its industry peers (24.7x), it means that investors are paying less than they should for each dollar of MX’s earnings. Therefore, according to this analysis, MX is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy MX immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to MX. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with MX, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing MX to are fairly valued by the market. If this does not hold true, MX’s lower P/E ratio may be because firms in our peer group are 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.