Shares of memory specialist Micron (NASDAQ:MU) have cratered over the past six months, shedding about 42% of their value since early June. If you're considering Micron as an investment, you may have noticed its trailing-12-month price-to-earnings ratio of about 2.6. That means the company's current market capitalization represents just 2.6 times the net income the company generated over the past 12 months.
That's insanely cheap, right? Well, while the stock does look cheap by that measure, the P/E ratio isn't really a good metric to use to determine how much value there is in Micron's shares. Here's why.
Look ahead, not back
Generally speaking, market prices for stocks are forward looking. After all, if you're buying a business, you probably care more about the profit it'll be able to generate in the years ahead than about what it's made in the past.
Right now, Micron's future earnings don't look as if they'll be as robust as in the past. Financial guidance for the current quarter calls for earnings per share (EPS) of $1.75, give or take $0.10, on a non-GAAP basis. In the year-ago period, Micron turned in EPS of $2.82. So things are definitely set to get worse.
The declines aren't likely to be limited to a single quarter, either. Current analyst estimates call for 2019 EPS of $7.88, down heavily from $11.95 in fiscal 2018. That decline is set to continue into the following year, during which analysts forecast Micron's EPS to be $7.05.
Now, even if we use the $7.05 figure, which could be revised upward or downward over time, Micron stock is trading at around 4.48 times expected fiscal 2020 earnings.
Micron shares are undoubtedly still cheap even on that basis, but certainly not as cheap as the trailing-12-month EPS numbers would signal.
What Micron investors need to focus on
I'm not here to make a hard call on Micron stock either way. The takeaway, one that you can apply more broadly, is that when a stock looks abnormally cheap -- or unusually expensive -- it's important to look at analysts' EPS expectations over the next year or two.
What you're likely to find is that if a stock looks absurdly cheap on a trailing-12-month basis, it's because earnings are expected to decline, and if a stock looks insanely expensive, odds are good that earnings are set to rise -- perhaps dramatically -- in the coming years.