Yahoo Finance Does AeroVironment Inc’s (NASDAQ:AVAV) PE Ratio Warrant A Sell?
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
AeroVironment Inc (NASDAQ:AVAV) is trading with a trailing P/E of 55.8, which is higher than the industry average of 24.9. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
See our latest analysis for AeroVironment
What you need to know about 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 AVAV
Price-Earnings Ratio = Price per share ÷ Earnings per share
AVAV Price-Earnings Ratio = $112.17 ÷ $2.009 = 55.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 AVAV, 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 AVAV’s P/E of 55.8 is higher than its industry peers (24.9), it means that investors are paying more for each dollar of AVAV’s earnings. This multiple is a median of profitable companies of 25 Aerospace & Defense companies in US including Environmental Tectonics, Optex Systems Holdings and Vectrus. You could think of it like this: the market is pricing AVAV as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to AVAV. If not, the difference in P/E might be a result of other factors. For example, AeroVironment Inc could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to AVAV may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
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 AVAV. 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. 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for AVAV’s future growth? Take a look at our free research report of analyst consensus for AVAV’s outlook.
Past Track Record: Has AVAV been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of AVAV’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
