The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Xilinx Inc (NASDAQ:XLNX) is trading with a trailing P/E of 32.7x, which is higher than the industry average of 21.9x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
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 XLNX
Price-Earnings Ratio = Price per share ÷ Earnings per share
XLNX Price-Earnings Ratio = $71.02 ÷ $2.174 = 32.7x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as XLNX, 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. At 32.7x, XLNX’s P/E is higher than its industry peers (21.9x). This implies that investors are overvaluing each dollar of XLNX’s earnings. This multiple is a median of profitable companies of 25 Semiconductor companies in US including Inside Secure, ARISE Technologies and Amtech Systems. As such, our analysis shows that XLNX represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your XLNX 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 XLNX. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with XLNX, then investors would naturally value it at a lower price since it is a riskier investment. 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:
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 XLNX. 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:
- 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 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.