Finisar Corporation (NASDAQ:FNSR) is currently trading at a trailing P/E of 19.6x, which is lower than the industry average of 29.7x. While this makes FNSR 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. View our latest analysis for Finisar
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 FNSR
Price-Earnings Ratio = Price per share ÷ Earnings per share
FNSR Price-Earnings Ratio = $17.37 ÷ $0.887 = 19.6x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to FNSR, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since FNSR’s P/E of 19.6x is lower than its industry peers (29.7x), it means that investors are paying less than they should for each dollar of FNSR’s earnings. Therefore, according to this analysis, FNSR is an under-priced stock.
A few caveats
However, before you rush out to buy FNSR, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to FNSR, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with FNSR, 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 FNSR to are fairly valued by the market. If this does not hold, there is a possibility that FNSR’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 FNSR 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for FNSR’s future growth? Take a look at our free research report of analyst consensus for FNSR’s outlook.
- Past Track Record: Has FNSR 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 FNSR’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.