Yahoo Finance Is Aspen Technology Inc’s (AZPN) PE Ratio A Signal To Buy For Investors?
Aspen Technology Inc (NASDAQ:AZPN) is trading with a trailing P/E of 30.2x, which is lower than the industry average of 33.7x. While AZPN might seem like an attractive stock to buy, 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. See our latest analysis for AZPN
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.
Formula
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for AZPN
Price per share = 64.11
Earnings per share = 2.12
∴ Price-Earnings Ratio = 64.11 ÷ 2.12 = 30.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AZPN, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
AZPN’s P/E of 30.2x is lower than its industry peers (33.7x), which implies that each dollar of AZPN’s earnings is being undervalued by investors. As such, our analysis shows that AZPN represents an under-priced stock.
A few caveats
Before you jump to the conclusion that AZPN represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to AZPN. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with AZPN, then investors would naturally value AZPN at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with AZPN, investors would also value AZPN at a lower price since it is a lower growth investment. Both scenarios would explain why AZPN has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing AZPN to are fairly valued by the market. If this assumption is violated, AZPN's P/E may be lower than its peers because its peers are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on AZPN, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I've outlined above.
Are you a potential investor? If you are considering investing in AZPN, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Aspen Technology for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass 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.
