Is DASAN Zhone Solutions Inc's (NASDAQ:DZSI) PE Ratio A Signal To Sell For Investors?

I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in DASAN Zhone Solutions Inc (NASDAQ:DZSI).

DASAN Zhone Solutions Inc (NASDAQ:DZSI) is trading with a trailing P/E of 33.2x, which is higher than the industry average of 31x. While this makes DZSI 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 explain what the P/E ratio is as well as what you should look out for when using it. View out our latest analysis for DASAN Zhone Solutions

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. 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.

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to DZSI, such as capital structure and profitability. 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 DZSI's P/E of 33.2x is higher than its industry peers (31x), it means that investors are paying more than they should for each dollar of DZSI's earnings. As such, our analysis shows that DZSI represents an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your DZSI shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to DZSI. 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 DZSI, then DZSI’s P/E would naturally be higher since investors would reward DZSI’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with DZSI, DZSI’s P/E would again be higher since investors would reward DZSI’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing DZSI to are fairly valued by the market. If this does not hold, there is a possibility that DZSI’s P/E is higher because firms in our peer group are being undervalued 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 rebalance your portfolio and reduce your holdings in DZSI. 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 highly recommend you to complete your research by taking a look at the following:

1. Financial Health: Is DZSI’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. 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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.