Is It Time To Buy Methanex Corporation (TSE:MX) Based Off Its PE Ratio?
Methanex Corporation (TSX:MX) trades with a trailing P/E of 19.3x, which is lower than the industry average of 24.1x. While this makes MX 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 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 Methanex
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 MX
Price-Earnings Ratio = Price per share ÷ Earnings per share
MX Price-Earnings Ratio = $59.59 ÷ $3.093 = 19.3x
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 MX, 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. Since MX’s P/E of 19.3x is lower than its industry peers (24.1x), it means that investors are paying less than they should for each dollar of MX’s earnings. Therefore, according to this analysis, MX is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy MX immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to MX. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with MX, 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 MX to are fairly valued by the market. If this does not hold true, MX’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 MX. 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 MX, 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 Methanex 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.
