This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Minerals Technologies Inc (NYSE:MTX) trades with a trailing P/E of 11.8x, which is lower than the industry average of 20.5x. 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down 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 MTX
Price-Earnings Ratio = Price per share ÷ Earnings per share
MTX Price-Earnings Ratio = $67.15 ÷ $5.7 = 11.8x
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 MTX, 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 MTX’s P/E of 11.8 is lower than its industry peers (20.5), it means that investors are paying less for each dollar of MTX’s earnings. This multiple is a median of profitable companies of 25 Chemicals companies in US including China SNX Organic Fertilizers, ONE Bio and Nocopi Technologies. You can think of it like this: the market is suggesting that MTX is a weaker business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to MTX. 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 MTX, 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 MTX to are fairly valued by the market. If this is violated, MTX’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to MTX. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for MTX’s future growth? Take a look at our free research report of analyst consensus for MTX’s outlook.
- Past Track Record: Has MTX 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 MTX’s historicals for more clarity.
- 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 firstname.lastname@example.org.