American Public Education Inc (NASDAQ:APEI) is currently trading at a trailing P/E of 33.1x, which is higher than the industry average of 21.5x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for American Public Education

Demystifying the P/E ratio

The P/E ratio is one of many ratios used in relative valuation. 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 APEI

Price-Earnings Ratio = Price per share ÷ Earnings per share

APEI Price-Earnings Ratio = $43.1 ÷ $1.301 = 33.1x

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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as APEI, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since APEI’s P/E of 33.1x is higher than its industry peers (21.5x), it means that investors are paying more than they should for each dollar of APEI’s earnings. Therefore, according to this analysis, APEI is an over-priced stock.

Assumptions to be aware of

However, before you rush out to sell your APEI shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to APEI. 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 APEI, 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 APEI to are fairly valued by the market. If this does not hold true, APEI’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

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.