Comtech Telecommunications Corp (NASDAQ:CMTL) is currently trading at a trailing P/E of 30.7x, which is higher than the industry average of 22.8x. While CMTL might seem like a stock to avoid or sell if you own it, 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 Comtech Telecommunications
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 CMTL
Price-Earnings Ratio = Price per share ÷ Earnings per share
CMTL Price-Earnings Ratio = $20.76 ÷ $0.675 = 30.7x
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 CMTL, 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 CMTL’s P/E of 30.7x is higher than its industry peers (22.8x), it means that investors are paying more than they should for each dollar of CMTL’s earnings. As such, our analysis shows that CMTL represents an over-priced stock.
A few caveats
However, before you rush out to sell your CMTL 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 CMTL. 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 CMTL, 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 CMTL to are fairly valued by the market. If this is violated, CMTL’s P/E may be lower than its peers as they are actually overpriced by investors.
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 rebalance your portfolio and reduce your holdings in CMTL. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.