Yahoo Finance Should You Be Tempted To Sell SLI Systems Limited (NZSE:SLI) Because Of Its PE Ratio?
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 SLI Systems Limited (NZSE:SLI).
SLI Systems Limited (NZSE:SLI) is trading with a trailing P/E of 32.4x, which is higher than the industry average of 31.4x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for SLI Systems
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.
P/E Calculation for SLI
Price-Earnings Ratio = Price per share ÷ Earnings per share
SLI Price-Earnings Ratio = NZ$0.29 ÷ NZ$0.00894 = 32.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SLI, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. SLI’s P/E of 32.4x is higher than its industry peers (32x), which implies that each dollar of SLI’s earnings is being overvalued by investors. As such, our analysis shows that SLI represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your SLI 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 SLI, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with SLI, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing SLI to are fairly valued by the market. If this does not hold, there is a possibility that SLI’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on SLI, the overvaluation of the stock may mean it is a good time to reduce 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for SLI’s future growth? Take a look at our free research report of analyst consensus for SLI’s outlook.
Past Track Record: Has SLI 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 SLI’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 pass 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.
