Tarena International Inc (NASDAQ:TEDU) trades with a trailing P/E of 23x, which is lower than the industry average of 24.5x. 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for TEDU
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 TEDU
Price-Earnings Ratio = Price per share ÷ Earnings per share
TEDU Price-Earnings Ratio = 14.5 ÷ 4.193 = 23x
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 TEDU, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since TEDU's P/E of 23x is lower than its industry peers (24.5x), it means that investors are paying less than they should for each dollar of TEDU's earnings. Therefore, according to this analysis, TEDU is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy TEDU immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to TEDU. 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 TEDU, 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 TEDU to are fairly valued by the market. If this does not hold true, TEDU’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of TEDU to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If TEDU 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 Tarena International 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.