The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Taitron Components Incorporated (NASDAQ:TAIT) is trading with a trailing P/E of 22.7x, which is lower than the industry average of 23.4x. While this makes TAIT appear like a great stock to buy, 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.
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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for TAIT
Price per share = $1.89
Earnings per share = $0.0831
∴ Price-Earnings Ratio = $1.89 ÷ $0.0831 = 22.7x
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 TAIT, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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 TAIT’s P/E of 22.7x is lower than its industry peers (23.4x), it means that investors are paying less than they should for each dollar of TAIT’s earnings. This multiple is a median of profitable companies of 25 Electronic companies in US including General Payment Systems, Circuit Research Labs and KMA Global Solutions International. Therefore, according to this analysis, TAIT is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy TAIT, 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 TAIT. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing lower risk firms with TAIT, then TAIT’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with TAIT. In this case, TAIT’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing TAIT to are fairly valued by the market. If this does not hold, there is a possibility that TAIT’s P/E is lower 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 TAIT 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:
- Financial Health: Is TAIT’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 TAIT 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 TAIT’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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.