Is It Time To Buy American Shared Hospital Services (NYSEMKT:AMS) Based Off Its PE Ratio?
American Shared Hospital Services (AMEX:AMS) is trading with a trailing P/E of 8x, which is lower than the industry average of 21.5x. While this makes AMS appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for American Shared Hospital Services
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 AMS
Price-Earnings Ratio = Price per share ÷ Earnings per share
AMS Price-Earnings Ratio = $2.8 ÷ $0.349 = 8x
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 AMS, 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. Since AMS’s P/E of 8x is lower than its industry peers (21.5x), it means that investors are paying less than they should for each dollar of AMS’s earnings. As such, our analysis shows that AMS represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that AMS is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to AMS, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with AMS, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing AMS to are fairly valued by the market. If this does not hold, there is a possibility that AMS’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of AMS to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 urge you to complete your research by taking a look at the following:
Financial Health: Is AMS’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 AMS 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 AMS’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.
