Woodward Inc (NASDAQ:WWD) is trading with a trailing P/E of 24.1x, which is lower than the industry average of 27.7x. While this makes WWD appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for WWD
Breaking down the Price-Earnings 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.
P/E Calculation for WWD
Price-Earnings Ratio = Price per share ÷ Earnings per share
WWD Price-Earnings Ratio = 78.97 ÷ 3.279 = 24.1x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to WWD, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since WWD's P/E of 24.1x is lower than its industry peers (27.7x), it means that investors are paying less than they should for each dollar of WWD's earnings. As such, our analysis shows that WWD represents an under-priced stock.
A few caveats
Before you jump to the conclusion that WWD is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to WWD. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with WWD, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing WWD to are fairly valued by the market. If this does not hold, there is a possibility that WWD’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to WWD. 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.
Are you a potential investor? If you are considering investing in WWD, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.