Does Woodward Inc's (NASDAQ:WWD) PE Ratio Signal A Buying Opportunity?

Woodward Inc (NASDAQ:WWD) is currently trading at a trailing P/E of 24.6x, which is lower than the industry average of 26.7x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Woodward

Breaking down the Price-Earnings ratio

P/E is a popular ratio used for 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.

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 WWD, 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 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.

Since WWD's P/E of 24.6x is lower than its industry peers (26.7x), it means that investors are paying less than they should for each dollar of WWD's earnings. As such, our analysis shows that WWD represents an under-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to buy WWD immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to WWD. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with WWD, then investors would naturally value WWD at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with WWD, investors would also value WWD at a lower price since it is a lower growth investment. Both scenarios would explain why WWD has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing WWD to are fairly valued by the market. If this assumption is violated, WWD's P/E may be lower than its peers because its peers are actually overvalued by investors.

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 add more of WWD to your portfolio. 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 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 WWD’s future growth? Take a look at our free research report of analyst consensus for WWD’s outlook.
• 2. Past Track Record: Has WWD 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 WWD'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.