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 better understand how you can grow your money by investing in Farmmi Inc (NASDAQ:FAMI).
Farmmi Inc (NASDAQ:FAMI) is currently trading at a trailing P/E of 25.5x, which is higher than the industry average of 19.1x. While this makes FAMI appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Farmmi
What you need to know about 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for FAMI
Price per share = $8.33
Earnings per share = $0.327
∴ Price-Earnings Ratio = $8.33 ÷ $0.327 = 25.5x
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 FAMI, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
Since FAMI’s P/E of 25.5x is higher than its industry peers (19.1x), it means that investors are paying more than they should for each dollar of FAMI’s earnings. This multiple is a median of profitable companies of 25 Food companies in US including China Fruits, Royal Hawaiian Orchards and Energroup Holdings. Therefore, according to this analysis, FAMI is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that FAMI should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to FAMI. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with FAMI, then FAMI’s P/E would naturally be higher since investors would reward FAMI’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with FAMI, FAMI’s P/E would again be higher since investors would reward FAMI’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing FAMI to are fairly valued by the market. If this assumption does not hold true, FAMI’s higher P/E ratio may be because firms in our peer group are being undervalued 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 FAMI. 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:
- Future Outlook: What are well-informed industry analysts predicting for FAMI’s future growth? Take a look at our free research report of analyst consensus for FAMI’s outlook.
- Financial Health: Is FAMI’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- 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.