Is NexJ Systems Inc (TSX:NXJ) A Buy At Its Current Price?
NexJ Systems Inc (TSX:NXJ) is currently trading at a trailing P/E of 19.1x, which is lower than the industry average of 34.6x. While this makes NXJ 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for NexJ Systems
What you need to know about 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. 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 NXJ
Price-Earnings Ratio = Price per share ÷ Earnings per share
NXJ Price-Earnings Ratio = 2.83 ÷ 0.148 = 19.1x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to NXJ, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 19.1x, NXJ’s P/E is lower than its industry peers (34.6x). This implies that investors are undervaluing each dollar of NXJ’s earnings. As such, our analysis shows that NXJ represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy NXJ, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to NXJ. 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 NXJ, 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 NXJ to are fairly valued by the market. If this does not hold, there is a possibility that NXJ’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on NXJ, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I've outlined above.
Are you a potential investor? If NXJ 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 NexJ Systems 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.
