Is Twin Disc Incorporated’s (NASDAQ:TWIN) PE Ratio A Signal To Sell For Investors?
I am writing today to help inform people who are new to the stock market and want to begin learning the link between Twin Disc Incorporated (NASDAQ:TWIN)’s fundamentals and stock market performance.
Twin Disc Incorporated (NASDAQ:TWIN) is trading with a trailing P/E of 61.5x, which is higher than the industry average of 22x. While this makes TWIN 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Twin Disc
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 TWIN
Price-Earnings Ratio = Price per share ÷ Earnings per share
TWIN Price-Earnings Ratio = $25.4 ÷ $0.413 = 61.5x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 TWIN, 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 TWIN’s P/E of 61.5x is higher than its industry peers (22x), it means that investors are paying more than they should for each dollar of TWIN’s earnings. As such, our analysis shows that TWIN represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your TWIN shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to TWIN, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with TWIN, 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 TWIN to are fairly valued by the market. If this does not hold, there is a possibility that TWIN’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to TWIN. 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. 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:
Financial Health: Is TWIN’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
Past Track Record: Has TWIN 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 TWIN’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.
