SigmaTron International Inc (NASDAQ:SGMA) is currently trading at a trailing P/E of 26.9x, which is higher than the industry average of 25x. While this makes SGMA appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for SGMA
What you need to know about the P/E ratio
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.
P/E Calculation for SGMA
Price-Earnings Ratio = Price per share ÷ Earnings per share
SGMA Price-Earnings Ratio = $10.45 ÷ $0.388 = 26.9x
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 SGMA, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. SGMA’s P/E of 26.9x is higher than its industry peers (25x), which implies that each dollar of SGMA’s earnings is being overvalued by investors. As such, our analysis shows that SGMA represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that SGMA should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to SGMA. 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 SGMA, 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 SGMA to are fairly valued by the market. If this is violated, SGMA’s P/E may be lower than its peers as they are actually overvalued by investors.
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 overvaluation could signal a potential selling opportunity to reduce your exposure to SGMA. 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 SGMA has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 SigmaTron International 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.