PCM Inc (NASDAQ:PCMI) is currently trading at a trailing P/E of 9.9x, which is lower than the industry average of 23x. While this makes PCMI 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 PCM
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 PCMI
Price-Earnings Ratio = Price per share ÷ Earnings per share
PCMI Price-Earnings Ratio = $8.35 ÷ $0.845 = 9.9x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as PCMI, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since PCMI’s P/E of 9.9x is lower than its industry peers (23x), it means that investors are paying less than they should for each dollar of PCMI’s earnings. As such, our analysis shows that PCMI represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy PCMI, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to PCMI. 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 PCMI, 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 PCMI to are fairly valued by the market. If this does not hold, there is a possibility that PCMI’s P/E is lower because our peer group is overvalued by the market.
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.