Finjan Holdings Inc (NASDAQ:FNJN) is currently trading at a trailing P/E of 6x, which is lower than the industry average of 35.1x. While this makes FNJN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Finjan Holdings
Demystifying 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 FNJN
Price-Earnings Ratio = Price per share ÷ Earnings per share
FNJN Price-Earnings Ratio = $2.19 ÷ $0.367 = 6x
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 FNJN, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since FNJN’s P/E of 6x is lower than its industry peers (35.1x), it means that investors are paying less than they should for each dollar of FNJN’s earnings. Therefore, according to this analysis, FNJN is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy FNJN, 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 FNJN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with FNJN, 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 FNJN to are fairly valued by the market. If this is violated, FNJN’s P/E may be lower than its peers as they are actually overvalued by investors.
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 FNJN. 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 FNJN, 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.