Loral Space & Communications Inc (NASDAQ:LORL) trades with a trailing P/E of 16.7x, which is lower than the industry average of 19.7x. 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. Today, 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 Loralce & Communications
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for LORL
Price per share = $44.05
Earnings per share = $2.639
∴ Price-Earnings Ratio = $44.05 ÷ $2.639 = 16.7x
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 LORL, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.
At 16.7x, LORL’s P/E is lower than its industry peers (19.7x). This implies that investors are undervaluing each dollar of LORL’s earnings. As such, our analysis shows that LORL represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that LORL 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 LORL. 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 LORL, then investors would naturally value LORL at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with LORL, investors would also value LORL at a lower price since it is a lower growth investment. Both scenarios would explain why LORL has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing LORL to are fairly valued by the market. If this assumption does not hold true, LORL’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
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 LORL 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 urge you to complete your research by taking a look at the following:
1. Financial Health: Is LORL’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.
2. Past Track Record: Has LORL 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 LORL’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.