Despite Its High P/E Ratio, Is Datacolor AG (VTX:DCN) Still Undervalued?

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at Datacolor AG’s (VTX:DCN) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, Datacolor has a P/E ratio of 36.94. That corresponds to an earnings yield of approximately 2.7%.

See our latest analysis for Datacolor

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Datacolor:

P/E of 36.94 = CHF648.11 (Note: this is the share price in the reporting currency, namely, USD ) ÷ CHF17.55 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Does Datacolor’s P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (20.9) for companies in the electronic industry is lower than Datacolor’s P/E.

SWX:DCN Price Estimation Relative to Market, October 22nd 2019
SWX:DCN Price Estimation Relative to Market, October 22nd 2019

Datacolor’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Datacolor shrunk earnings per share by 51% over the last year. And over the longer term (5 years) earnings per share have decreased 7.6% annually. This might lead to muted expectations.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does Datacolor’s Debt Impact Its P/E Ratio?

Datacolor has net cash of US$38m. This is fairly high at 35% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Datacolor’s P/E Ratio

Datacolor has a P/E of 36.9. That’s higher than the average in its market, which is 18.7. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Datacolor. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.