Xilinx Inc (NASDAQ:XLNX) is trading with a trailing P/E of 34.6x, which is higher than the industry average of 24.9x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, 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 Xilinx
Breaking down the P/E ratio
P/E is a popular ratio used for 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 XLNX
Price-Earnings Ratio = Price per share ÷ Earnings per share
XLNX Price-Earnings Ratio = $70.99 ÷ $2.053 = 34.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to XLNX, 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. At 34.6x, XLNX’s P/E is higher than its industry peers (24.9x). This implies that investors are overvaluing each dollar of XLNX’s earnings. Therefore, according to this analysis, XLNX is an over-priced stock.
A few caveats
However, before you rush out to sell your XLNX shares, 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 XLNX, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with XLNX, 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 XLNX to are fairly valued by the market. If this does not hold true, XLNX’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on XLNX, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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:
- Future Outlook: What are well-informed industry analysts predicting for XLNX’s future growth? Take a look at our free research report of analyst consensus for XLNX’s outlook.
- Past Track Record: Has XLNX 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 XLNX’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.