Should You Sell Judges Scientific plc (AIM:JDG) At £19.075?
Judges Scientific plc (AIM:JDG) trades with a trailing P/E of 45.8x, which is higher than the industry average of 22.9x. While this makes JDG appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Judges Scientific
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 pound of the company’s earnings.
P/E Calculation for JDG
Price-Earnings Ratio = Price per share ÷ Earnings per share
JDG Price-Earnings Ratio = 19.08 ÷ 0.417 = 45.8x
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 JDG, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. JDG’s P/E of 45.8x is higher than its industry peers (22.9x), which implies that each dollar of JDG’s earnings is being overvalued by investors. Therefore, according to this analysis, JDG is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your JDG shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to JDG, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with JDG, 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 JDG to are fairly valued by the market. If this is violated, JDG’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on JDG, 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 JDG, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 Judges Scientific 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.
