Should You Be Tempted To Buy Educational Development Corporation (EDUC) Because Of Its PE Ratio?
Educational Development Corporation (NASDAQ:EDUC) is currently trading at a trailing P/E of 11.5x, which is lower than the industry average of 20.6x. 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. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for EDUC
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 EDUC
Price-Earnings Ratio = Price per share ÷ Earnings per share
EDUC Price-Earnings Ratio = 9.75 ÷ 0.849 = 11.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as EDUC, 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 EDUC's P/E of 11.5x is lower than its industry peers (20.6x), it means that investors are paying less than they should for each dollar of EDUC's earnings. As such, our analysis shows that EDUC represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy EDUC immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to EDUC. 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 EDUC, 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 EDUC to are fairly valued by the market. If this does not hold true, EDUC’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? Since you may have already conducted your due diligence on EDUC, the undervaluation of the stock may mean it is a good time to top up on 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.
Are you a potential investor? If you are considering investing in EDUC, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 Educational Development 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.
