I am writing today to help inform people who are new to the stock market and want to begin learning the link between Key Technology Inc (NASDAQ:KTEC)’s fundamentals and stock market performance.
Key Technology Inc (NASDAQ:KTEC) is currently trading at a trailing P/E of 88x, which is higher than the industry average of 21.9x. While KTEC might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, 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 Key Technology
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 KTEC
Price-Earnings Ratio = Price per share ÷ Earnings per share
KTEC Price-Earnings Ratio = $26.74 ÷ $0.304 = 88x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to KTEC, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 88x, KTEC’s P/E is higher than its industry peers (21.9x). This implies that investors are overvaluing each dollar of KTEC’s earnings. Therefore, according to this analysis, KTEC is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that KTEC should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to KTEC, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with KTEC, 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 KTEC to are fairly valued by the market. If this is violated, KTEC’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on KTEC, the overvaluation of the stock may mean it is a good time to reduce 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. 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 highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is KTEC’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has KTEC 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 KTEC’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 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.