Phibro Animal Health Corporation (NASDAQ:PAHC) is currently trading at a trailing P/E of 24.8x, which is higher than the industry average of 23.5x. While PAHC might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Phibro Animal Health
Demystifying 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 PAHC
Price-Earnings Ratio = Price per share ÷ Earnings per share
PAHC Price-Earnings Ratio = $38.55 ÷ $1.554 = 24.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as PAHC, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 24.8x, PAHC’s P/E is higher than its industry peers (23.5x). This implies that investors are overvaluing each dollar of PAHC’s earnings. As such, our analysis shows that PAHC represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your PAHC shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to PAHC. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with PAHC, 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 PAHC to are fairly valued by the market. If this does not hold true, PAHC’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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.