This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Park Electrochemical Corp (NYSE:PKE) is trading with a trailing P/E of 17.9x, which is lower than the industry average of 28.2x. 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.
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 PKE
Price-Earnings Ratio = Price per share ÷ Earnings per share
PKE Price-Earnings Ratio = $19.75 ÷ $1.105 = 17.9x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to PKE, 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. PKE’s P/E of 17.9 is lower than its industry peers (28.2), which implies that each dollar of PKE’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 25 Electronic companies in US including Electro Scientific Industries, Evans & Sutherland Computer and Surge Components. One could put it like this: the market is pricing PKE as if it is a weaker company than the average company in its industry.
A few caveats
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to PKE. 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 PKE, 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 PKE to are fairly valued by the market. If this does not hold, there is a possibility that PKE’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
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 PKE. 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. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for PKE’s future growth? Take a look at our free research report of analyst consensus for PKE’s outlook.
- Past Track Record: Has PKE been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of PKE’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past 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. For errors that warrant correction please contact the editor at email@example.com.