Dynasil Corporation of America (NASDAQ:DYSL) is trading with a trailing P/E of 8.4x, which is lower than the industry average of 26x. While this makes DYSL 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 DYSL
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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 DYSL
Price-Earnings Ratio = Price per share ÷ Earnings per share
DYSL Price-Earnings Ratio = 1.47 ÷ 0.176 = 8.4x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to DYSL, 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 8.4x, DYSL’s P/E is lower than its industry peers (26x). This implies that investors are undervaluing each dollar of DYSL’s earnings. Therefore, according to this analysis, DYSL is an under-priced stock.
A few caveats
Before you jump to the conclusion that DYSL is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to DYSL. 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 DYSL, 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 DYSL to are fairly valued by the market. If this is violated, DYSL's P/E may be lower than its peers as they are actually overvalued by investors.
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 DYSL. 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 DYSL, 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 Dynasil of America 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.