Universal Display Corporation (NASDAQ:OLED) is trading with a trailing P/E of 87.3x, which is higher than the industry average of 23.3x. While OLED 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 Universal Display
Breaking down the P/E ratio
P/E is a popular ratio used for 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 OLED
Price-Earnings Ratio = Price per share ÷ Earnings per share
OLED Price-Earnings Ratio = $179.3 ÷ $2.053 = 87.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to OLED, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since OLED’s P/E of 87.3x is higher than its industry peers (23.3x), it means that investors are paying more than they should for each dollar of OLED’s earnings. Therefore, according to this analysis, OLED is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your OLED shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to OLED, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with OLED, 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 OLED to are fairly valued by the market. If this does not hold, there is a possibility that OLED’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to OLED. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.