JCurve Solutions Limited (ASX:JCS) trades with a trailing P/E of 13x, which is lower than the industry average of 31.3x. While JCS 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for JCurve Solutions

Demystifying 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.

P/E Calculation for JCS

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

JCS Price-Earnings Ratio = A$0.04 ÷ A$0.003 = 13x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to JCS, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. JCS’s P/E of 13x is lower than its industry peers (31.3x), which implies that each dollar of JCS’s earnings is being undervalued by investors. Therefore, according to this analysis, JCS is an under-priced stock.

A few caveats

However, before you rush out to buy JCS, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to JCS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with JCS, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing JCS to are fairly valued by the market. If this does not hold, there is a possibility that JCS’s P/E is lower because our peer group is 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.