Should You Sell KLX Inc (NASDAQ:KLXI) At This PE Ratio?
KLX Inc (NASDAQ:KLXI) is trading with a trailing P/E of 70.2x, which is higher than the industry average of 22.7x. While this makes KLXI appear like a stock to avoid or sell if you own it, 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. View our latest analysis for KLX
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. 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 KLXI
Price-Earnings Ratio = Price per share ÷ Earnings per share
KLXI Price-Earnings Ratio = $74.19 ÷ $1.057 = 70.2x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to KLXI, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. KLXI’s P/E of 70.2x is higher than its industry peers (22.7x), which implies that each dollar of KLXI’s earnings is being overvalued by investors. Therefore, according to this analysis, KLXI is an over-priced stock.
A few caveats
Before you jump to the conclusion that KLXI should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to KLXI. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with KLXI, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing KLXI to are fairly valued by the market. If this is violated, KLXI’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on KLXI, 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for KLXI’s future growth? Take a look at our free research report of analyst consensus for KLXI’s outlook.
Past Track Record: Has KLXI 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 KLXI’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.
