Zytronic plc (AIM:ZYT) is currently trading at a trailing P/E of 19.2x, which is lower than the industry average of 32.2x. While ZYT might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 our latest analysis for Zytronic
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 pound of the company’s earnings.
P/E Calculation for ZYT
Price-Earnings Ratio = Price per share ÷ Earnings per share
ZYT Price-Earnings Ratio = 5.9 ÷ 0.307 = 19.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ZYT, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 19.2x, ZYT’s P/E is lower than its industry peers (32.2x). This implies that investors are undervaluing each dollar of ZYT’s earnings. Therefore, according to this analysis, ZYT is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy ZYT immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to ZYT. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with ZYT, 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 ZYT to are fairly valued by the market. If this does not hold true, ZYT’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? 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 ZYT 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.
Are you a potential investor? If you are considering investing in ZYT, 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.