Should You Be Tempted To Buy HP Inc (HPQ) Because Of Its PE Ratio?
HP Inc (NYSE:HPQ) is trading with a trailing P/E of 14.3x, which is lower than the industry average of 21x. While HPQ might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for HP
Breaking down 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 HPQ
Price-Earnings Ratio = Price per share ÷ Earnings per share
HPQ Price-Earnings Ratio = 19.97 ÷ 1.4 = 14.3x
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 HPQ, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. HPQ’s P/E of 14.3x is lower than its industry peers (21x), which implies that each dollar of HPQ’s earnings is being undervalued by investors. Therefore, according to this analysis, HPQ is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy HPQ, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to HPQ, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with HPQ, 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 HPQ to are fairly valued by the market. If this does not hold, there is a possibility that HPQ’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on HPQ, 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 HPQ, 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 HP 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.
