This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Wilhelmina International Inc (NASDAQ:WHLM) trades with a trailing P/E of 43.4, which is higher than the industry average of 22.4. Though this might seem to be a negative, 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.
Breaking down 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 WHLM
Price-Earnings Ratio = Price per share ÷ Earnings per share
WHLM Price-Earnings Ratio = $6.42 ÷ $0.148 = 43.4x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as WHLM, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since WHLM’s P/E of 43.4 is higher than its industry peers (22.4), it means that investors are paying more for each dollar of WHLM’s earnings. This multiple is a median of profitable companies of 25 Commercial Services companies in US including Nutrition Management Services, Eco Energy Tech Asia and QPS Die Cutters and Finishers. You could think of it like this: the market is pricing WHLM as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to WHLM. If not, the difference in P/E might be a result of other factors. For example, Wilhelmina International Inc could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to WHLM may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
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 WHLM. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for WHLM’s future growth? Take a look at our free research report of analyst consensus for WHLM’s outlook.
- Past Track Record: Has WHLM 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 WHLM’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 past 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. For errors that warrant correction please contact the editor at email@example.com.