How to Evaluate if a Company is Fairly Valued Using the PE Ratio?
- Max Teh
- Jan 23
- 4 min read
Updated: Jul 7
Table of Contents
Disclaimer: This communication is provided for information purposes only and is not intended as a recommendation or a solicitation to buy, sell or hold any investment product. Readers are solely responsible for their own investment decisions.
When analyzing whether a company is fairly valued from a PE ratio perspective, it’s important to assess more than just the absolute value of the ratio. The following framework provides a systematic approach to determine if the company is trading at a reasonable valuation:
A Stock is Considered Fairly Valued from a PE perspective when:
The Current PE Ratio is Below the Past 5 Years PE Median line
This indicates that the stock might be undervalued compared to its historical valuation trends.
The Company’s EPS (Net Income) has been Increasing in the past and is expected to continue to increase at or more than your targetted rate of returns in the foreseeable future.
Things to look for, is the company:
still growing its Revenue?
reducing (or planning to) its COGS & OPEX which will result in higher Net Income
reducing (or planning to) its shares outstanding (through shares repurchase) which will increase its Earnings Per Share?
Areas to look for this, evaluate the company's underlying fundamentals, growth prospects and also the guidance they provide for the upcoming periods, these will give you an idea if the company is heading towards the right direction.
Fortinet example Using Fortinet as an example, say if my targetted rate of returns for the stock is 20% per year, as long as the company is able to increase its EPS by higher than 20% (attributable by either an increase in its Net Income or / and combined with reduction of its shares outstanding, through shares purchase), its PE ratio will continue to decrease.
Bonus: when (Past 12 months EPS growth rate + Dividend yield) > current PE ratio
Not favourable when the current P/E ratio is higher than past Net Income growth rate + Dividend Yield multiply by 2 [1]
Bonus: PEG is < 1
Not a deal breaker however when PEG > 2
since PEG is calculated with PE divided by Expected EPS growth,
Expected EPS growth requires analysts' forecasts and they are often subjected to mistakes since projecting future earnings is no easy business.
Furthermore there have been a few cases where there are many stocks which prices continue to rise even when its PEG was > 2, for example:
Fortinet's PEG was mostly above the 2 line in the past 5 years
and yet its stock price rose 482% in the same period
Axon's PEG was consistently above 2 in the past 5 years
and yet its stock price rose almost 8x in the same period.
Other notable examples include Microsoft, Apple & SPS Commerce.
The Profit Margin has been Increasing in the past and is expected to continue to improve in the future.
An expanding profit margin suggests improved operational efficiency, pricing power, or reduced costs, further supporting sustainable earnings growth.
How to Find the PE Ratio Trend?
To view the PE ratio for up to past 20 years period, Visit financecharts.com > Valuation Charts > Select PE Ratio > Adjust the timeframe accordingly
For companies that have only recently turned profitable, the 3-year period may provide more meaningful insights.
To obtain the Median line of the PE ratio, finchat.io > Charting page does a great job for that.
How to Find the PEG Ratio Trend?
visit Stockanalysis.com > Financials > Ratios, adjust period to Quarterly basis.
Examples of Companies That Fit the Framework
1. Fortinet (FTNT) – PE Ratio: 46x
✅ PE Ratio: Current PE is below the Median line of the past 5 years.
✅ Net Income: Increasing consistently.
✅ Past 12 months EPS Growth rate (52%) higher than current P/E ratio (46x)
❌ PEG > 1
✅ Profit Margin: Improving steadily.
2. MercadoLibre (MELI) – PE Ratio: 64x
✅ PE Ratio: Current PE is below the Median line of the past 2.4 years (5 years period is not usable because the company just turned profitable).
✅ Net Income: Growing steadily.
however past year Net Income Growth of 46% is not higher than current PE ratio of 65x.
😐 PEG = 1.59
✅ Profit Margin: Gradually improving.
Examples of Companies That Don’t Fit the Framework
1. Apple (AAPL) – PE Ratio: 37x
❌ PE Ratio: Current PE is above the median line of the past 5 years.
❌ Net Income: Flat or declining.
❌ PEG > 2
❌ Profit Margin: Moving sideways, showing no improvement.
Notes on Limitations of this Method
This method is not as applicable to companies that are:
Not Yet Profitable: Without earnings, the PE ratio isn’t meaningful.
Just Turned Profitable: In such cases, it’s better to use the PS (Price-to-Sales) Ratio for valuation analysis.
📖 For more insights, read: Avoid Investing in Stocks with PS Ratios Above 18x When Stock is at All-Time High Level.
Final Thoughts
By combining the PE ratio trend with growth in net income and profit margins, you can form a more holistic view of whether a stock is trading at a fair valuation. This method is especially useful for investors focused on fundamentally strong companies that are still undervalued relative to their historical performance.
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