The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in EMCORE Corporation (NASDAQ:EMKR).
EMCORE Corporation (NASDAQ:EMKR) trades with a trailing P/E of 99.8x, which is higher than the industry average of 29.1x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, 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 EMCORE
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 EMKR
Price-Earnings Ratio = Price per share ÷ Earnings per share
EMKR Price-Earnings Ratio = $5.35 ÷ $0.0536 = 99.8x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 EMKR, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since EMKR’s P/E of 99.8x is higher than its industry peers (29.1x), it means that investors are paying more than they should for each dollar of EMKR’s earnings. Therefore, according to this analysis, EMKR is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your EMKR shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to EMKR, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with EMKR, 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 EMKR to are fairly valued by the market. If this does not hold, there is a possibility that EMKR’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on EMKR, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 EMKR’s future growth? Take a look at our free research report of analyst consensus for EMKR’s outlook.
- Past Track Record: Has EMKR 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 EMKR’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.