This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Western Digital Corporation (NASDAQ:WDC)’s fundamentals and stock market performance.
Western Digital Corporation (NASDAQ:WDC) is currently trading at a trailing P/E of 119.2x, which is higher than the industry average of 17.6x. While this makes WDC 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. View out our latest analysis for Western Digital
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 WDC
Price-Earnings Ratio = Price per share ÷ Earnings per share
WDC Price-Earnings Ratio = $80.51 ÷ $0.675 = 119.2x
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 WDC, 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. WDC’s P/E of 119.2x is higher than its industry peers (17.6x), which implies that each dollar of WDC’s earnings is being overvalued by investors. Therefore, according to this analysis, WDC is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your WDC shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to WDC. 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 WDC, 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 WDC to are fairly valued by the market. If this does not hold, there is a possibility that WDC’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 rebalance your portfolio and reduce your holdings in WDC. 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 WDC’s future growth? Take a look at our free research report of analyst consensus for WDC’s outlook.
- Past Track Record: Has WDC 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 WDC’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.