Applied Genetic Technologies Corporation (NASDAQ:AGTC) is trading with a trailing P/E of 153.2x, which is higher than the industry average of 26.9x. While AGTC might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Applied Genetic Technologies
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 AGTC
Price-Earnings Ratio = Price per share ÷ Earnings per share
AGTC Price-Earnings Ratio = 3.45 ÷ 0.023 = 153.2x
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 AGTC, 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. AGTC’s P/E of 153.2x is higher than its industry peers (26.9x), which implies that each dollar of AGTC’s earnings is being overvalued by investors. As such, our analysis shows that AGTC represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your AGTC shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to AGTC, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with AGTC, 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 AGTC to are fairly valued by the market. If this is violated, AGTC’s P/E may be lower than its peers as they are actually overpriced by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on AGTC, the overvaluation of the stock may mean it is a good time to reduce 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 AGTC, 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 Applied Genetic Technologies 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.