Apollo Medical Holdings Inc (NASDAQ:AMEH) is trading with a trailing P/E of 16.9x, which is lower than the industry average of 21.5x. While AMEH might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Apollo Medical Holdings
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 AMEH
Price per share = $14.61
Earnings per share = $0.863
∴ Price-Earnings Ratio = $14.61 ÷ $0.863 = 16.9x
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. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AMEH, such as company lifetime and products sold. 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.
At 16.9x, AMEH’s P/E is lower than its industry peers (21.5x). This implies that investors are undervaluing each dollar of AMEH’s earnings. As such, our analysis shows that AMEH represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy AMEH, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to AMEH. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with AMEH, then investors would naturally value AMEH at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with AMEH, investors would also value AMEH at a lower price since it is a lower growth investment. Both scenarios would explain why AMEH has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing AMEH to are fairly valued by the market. If this assumption is violated, AMEH’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 AMEH. 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:
- Future Outlook: What are well-informed industry analysts predicting for AMEH’s future growth? Take a look at our free research report of analyst consensus for AMEH’s outlook.
- Financial Health: Is AMEH’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.