This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Casa Systems Inc (NASDAQ:CASA)’s fundamentals and stock market performance.
Casa Systems Inc (NASDAQ:CASA) is trading with a trailing P/E of 34.3x, which is higher than the industry average of 28.9x. While this makes CASA 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. View out our latest analysis for Casa Systems
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for CASA
Price per share = $15.94
Earnings per share = $0.465
∴ Price-Earnings Ratio = $15.94 ÷ $0.465 = 34.3x
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 CASA, such as company lifetime and products sold. 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 34.3x, CASA’s P/E is higher than its industry peers (28.9x). This implies that investors are overvaluing each dollar of CASA’s earnings. This multiple is a median of profitable companies of 25 Communications companies in US including GuanHua, Inventergy Global and ZST Digital Networks. As such, our analysis shows that CASA represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your CASA shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to CASA. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared riskier firms with CASA, then investors would naturally value CASA at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with CASA, investors would also value CASA at a higher price since it is a higher growth investment. Both scenarios would explain why CASA has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing CASA to are fairly valued by the market. If this assumption does not hold true, CASA’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 CASA. 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 CASA’s future growth? Take a look at our free research report of analyst consensus for CASA’s outlook.
- Financial Health: Is CASA’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.