ProPhase Labs Inc (NASDAQ:PRPH) is trading with a trailing P/E of 2.4x, which is lower than the industry average of 24.1x. While this makes PRPH 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. See our latest analysis for PRPH
Demystifying 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 PRPH
Price-Earnings Ratio = Price per share ÷ Earnings per share
PRPH Price-Earnings Ratio = 2.14 ÷ 0.893 = 2.4x
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 PRPH, 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. At 2.4x, PRPH’s P/E is lower than its industry peers (24.1x). This implies that investors are undervaluing each dollar of PRPH’s earnings. Therefore, according to this analysis, PRPH is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy PRPH, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to PRPH. 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 PRPH, 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 PRPH to are fairly valued by the market. If this does not hold, there is a possibility that PRPH’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? 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 PRPH. 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.
Are you a potential investor? If PRPH 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 ProPhase Labs 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.