This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
PCM Inc (NASDAQ:PCMI) is trading with a trailing P/E of 31, 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 explain what the P/E ratio is as well as what you should look out for when using it.
Demystifying 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 PCMI
Price-Earnings Ratio = Price per share ÷ Earnings per share
PCMI Price-Earnings Ratio = $18.76 ÷ $0.605 = 31x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to PCMI, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. PCMI’s P/E of 31 is higher than its industry peers (27.1), which implies that each dollar of PCMI’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 PCMI as if it is a stronger company than the average of its industry group.
A few caveats
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to PCMI. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where PCM Inc is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with PCMI are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being 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 PCMI. 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 PCMI’s future growth? Take a look at our free research report of analyst consensus for PCMI’s outlook.
- Past Track Record: Has PCMI 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 PCMI’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 email@example.com.