Does Etrion Corporation's (TSE:ETX) PE Ratio Signal A Buying Opportunity?

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.

Etrion Corporation (TSE:ETX) is currently trading at a trailing P/E of 2.6, which is lower than the industry average of 40.7. Although some investors might think this is a real positive, that might change once you understand the assumptions behind the P/E. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.

See our latest analysis for Etrion

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.

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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as ETX, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.

ETX’s P/E of 2.6 is lower than its industry peers (40.7), which implies that each dollar of ETX’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 6 Renewable Energy companies in CA including Northland Power, Polaris Infrastructure and TransAlta Renewables. One could put it like this: the market is pricing ETX as if it is a weaker company than the average company in its industry.

A few caveats

Before you jump to conclusions it is important to realise that our assumptions rests on two important assertions. The first is that our peer group actually contains companies that are similar to ETX. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with ETX, then ETX’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with ETX, ETX’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing ETX to are fairly valued by the market. If this assumption is violated, ETX's P/E may be lower than its peers because its peers are actually overvalued by investors.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to ETX. 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 urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for ETX’s future growth? Take a look at our free research report of analyst consensus for ETX’s outlook.
2. Past Track Record: Has ETX 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 ETX's historicals for more clarity.
3. 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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.