Should You Be Tempted To Sell ASML Holding NV (AMS:ASML) Because Of Its PE Ratio?

This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.

ASML Holding NV (AMS:ASML) is currently trading at a trailing P/E of 33x, which is higher than the industry average of 23.6x. While ASML might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, 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 ASML Holding

What you need to know about the P/E ratio

The P/E ratio is one of many ratios used in relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see 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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to ASML, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use below. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.

At 33x, ASML’s P/E is higher than its industry peers (23.6x). This implies that investors are overvaluing each dollar of ASML’s earnings. Since the Semiconductor sector in NL is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as ASM International, BE Semiconductor Industries and BE Semiconductor Industries. Therefore, according to this analysis, ASML is an over-priced stock.

A few caveats

While our conclusion might prompt you to sell your ASML shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to ASML. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with ASML, then investors would naturally value ASML at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with ASML, investors would also value ASML at a higher price since it is a higher growth investment. Both scenarios would explain why ASML has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing ASML to are fairly valued by the market. If this assumption is violated, ASML's P/E may be higher than its peers because its peers are actually undervalued by investors.

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 ASML. 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:

1. Future Outlook: What are well-informed industry analysts predicting for ASML’s future growth? Take a look at our free research report of analyst consensus for ASML’s outlook.
2. Past Track Record: Has ASML 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 ASML'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.

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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.