In This Article:
Westlake Chemical Corporation (NYSE:WLK) trades with a trailing P/E of 10.4x, which is lower than the industry average of 18.1x. While WLK 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Westlake Chemical
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 WLK
Price-Earnings Ratio = Price per share ÷ Earnings per share
WLK Price-Earnings Ratio = $116.4 ÷ $11.183 = 10.4x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to WLK, 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. At 10.4x, WLK’s P/E is lower than its industry peers (18.1x). This implies that investors are undervaluing each dollar of WLK’s earnings. As such, our analysis shows that WLK represents an under-priced stock.
A few caveats
However, before you rush out to buy WLK, 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 WLK, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with WLK, 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 WLK to are fairly valued by the market. If this is violated, WLK’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
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 WLK 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. 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 highly recommend you to complete your research by taking a look at the following: