Sypris Solutions Inc (NASDAQ:SYPR) trades with a trailing P/E of 3.2x, which is lower than the industry average of 15x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Sypris Solutions
Demystifying the P/E 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 SYPR
Price-Earnings Ratio = Price per share ÷ Earnings per share
SYPR Price-Earnings Ratio = 1.55 ÷ 0.482 = 3.2x
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 SYPR, 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. SYPR’s P/E of 3.2x is lower than its industry peers (15x), which implies that each dollar of SYPR’s earnings is being undervalued by investors. As such, our analysis shows that SYPR represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy SYPR immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SYPR. 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 SYPR, 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 SYPR to are fairly valued by the market. If this does not hold, there is a possibility that SYPR’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 SYPR. 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 you are considering investing in SYPR, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 Sypris Solutions 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.