Atrion Corporation (NASDAQ:ATRI) is trading with a trailing P/E of 30.4x, which is lower than the industry average of 33.8x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Atrion
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 ATRI
Price per share = $603.5
Earnings per share = $19.823
∴ Price-Earnings Ratio = $603.5 ÷ $19.823 = 30.4x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against 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 ATRI, such as company lifetime and products sold. 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.
Since ATRI’s P/E of 30.4x is lower than its industry peers (33.8x), it means that investors are paying less than they should for each dollar of ATRI’s earnings. Therefore, according to this analysis, ATRI is an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that ATRI represents the perfect buying opportunity, 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 ATRI. 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 ATRI, then investors would naturally value ATRI at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with ATRI, investors would also value ATRI at a lower price since it is a lower growth investment. Both scenarios would explain why ATRI has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing ATRI to are fairly valued by the market. If this assumption does not hold true, ATRI’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on ATRI, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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:
- Financial Health: Is ATRI’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.
- Past Track Record: Has ATRI 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 ATRI’s historicals for more clarity.
- 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.