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Should You Be Tempted To Buy Virco Mfg Corporation (VIRC) Because Of Its PE Ratio?

Virco Mfg Corporation (NASDAQ:VIRC) is trading with a trailing P/E of 3.7x, which is lower than the industry average of 32.9x. While VIRC 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Virco Mfg

What you need to know about the P/E ratio

NasdaqGM:VIRC PE PEG Gauge Sep 12th 17
NasdaqGM:VIRC PE PEG Gauge Sep 12th 17

P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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.

Formula

Price-Earnings Ratio = Price per share ÷ Earnings per share

P/E Calculation for VIRC

Price per share = 5.85

Earnings per share = 1.568

∴ Price-Earnings Ratio = 5.85 ÷ 1.568 = 3.7x

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 VIRC, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use below. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.

VIRC’s P/E of 3.7x is lower than its industry peers (32.9x), which implies that each dollar of VIRC’s earnings is being undervalued by investors. As such, our analysis shows that VIRC represents an under-priced stock.

A few caveats

While our conclusion might prompt you to buy VIRC immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to VIRC. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing lower risk firms with VIRC, then VIRC’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with VIRC. In this case, VIRC’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing VIRC to are fairly valued by the market. If this assumption is violated, VIRC's P/E may be lower than its peers because its peers are actually overpriced by investors.

NasdaqGM:VIRC Future Profit Sep 12th 17
NasdaqGM:VIRC Future Profit Sep 12th 17

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 VIRC. 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 VIRC, 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 Virco Mfg 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.