Is It Time To Buy Applied Materials Inc (NASDAQ:AMAT) Based Off Its PE Ratio?
Applied Materials Inc (NASDAQ:AMAT) is trading with a trailing P/E of 16.7x, which is lower than the industry average of 20.3x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Applied Materials
Demystifying 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 AMAT
Price-Earnings Ratio = Price per share ÷ Earnings per share
AMAT Price-Earnings Ratio = $53.45 ÷ $3.2 = 16.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 AMAT, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. AMAT’s P/E of 16.7x is lower than its industry peers (20.3x), which implies that each dollar of AMAT’s earnings is being undervalued by investors. Therefore, according to this analysis, AMAT is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy AMAT immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to AMAT, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with AMAT, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing AMAT to are fairly valued by the market. If this is violated, AMAT’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 undervaluation could signal a good buying opportunity to increase your exposure to AMAT. 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 AMAT, 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 Applied Materials 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.
