O2Micro International Limited (NASDAQ:OIIM) is currently trading at a trailing P/E of 16.1x, which is lower than the industry average of 24.8x. While OIIM might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 O2Micro International
Breaking down the Price-Earnings 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 OIIM
Price-Earnings Ratio = Price per share ÷ Earnings per share
OIIM Price-Earnings Ratio = $1.55 ÷ $0.096 = 16.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to OIIM, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since OIIM’s P/E of 16.1x is lower than its industry peers (24.8x), it means that investors are paying less than they should for each dollar of OIIM’s earnings. Therefore, according to this analysis, OIIM is an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that OIIM is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to OIIM, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with OIIM, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing OIIM to are fairly valued by the market. If this does not hold, there is a possibility that OIIM’s P/E is lower because our peer group is overvalued by the market.
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 OIIM. 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:
- Future Outlook: What are well-informed industry analysts predicting for OIIM’s future growth? Take a look at our free research report of analyst consensus for OIIM’s outlook.
- Past Track Record: Has OIIM 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 OIIM’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 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.