AudioCodes Ltd (NASDAQ:AUDC) is trading with a trailing P/E of 12.9x, which is lower than the industry average of 21.2x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for AudioCodes
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 AUDC
Price-Earnings Ratio = Price per share ÷ Earnings per share
AUDC Price-Earnings Ratio = $7.36 ÷ $0.569 = 12.9x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as AUDC, 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. At 12.9x, AUDC’s P/E is lower than its industry peers (21.2x). This implies that investors are undervaluing each dollar of AUDC’s earnings. As such, our analysis shows that AUDC represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy AUDC immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to AUDC. 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 AUDC, 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 AUDC to are fairly valued by the market. If this does not hold true, AUDC’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? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to AUDC. 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.
Are you a potential investor? If you are considering investing in AUDC, 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.