This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
PFSweb Inc (NASDAQ:PFSW) is currently trading at a trailing P/E of 73.6, which is higher than the industry average of 26.6. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. 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 PFSW
Price-Earnings Ratio = Price per share ÷ Earnings per share
PFSW Price-Earnings Ratio = $8.14 ÷ $0.111 = 73.6x
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 PFSW, 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. Since PFSW’s P/E of 73.6 is higher than its industry peers (26.6), it means that investors are paying more for each dollar of PFSW’s earnings. This multiple is a median of profitable companies of 25 IT companies in US including e-Synergies, Steel Connect and Net 1 UEPS Technologies. You could think of it like this: the market is pricing PFSW as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to PFSW. If this isn’t the case, the difference in P/E could be due to other factors. For example, if PFSweb Inc is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with PFSW are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in PFSW. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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 PFSW’s future growth? Take a look at our free research report of analyst consensus for PFSW’s outlook.
- Past Track Record: Has PFSW 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 PFSW’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.