Should You Be Tempted To Buy Microgen plc (LON:MCGN) At Its Current PE Ratio?
Microgen plc (LSE:MCGN) is currently trading at a trailing P/E of 29.9x, which is lower than the industry average of 30.4x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Microgen
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each pound of the company’s earnings.
P/E Calculation for MCGN
Price-Earnings Ratio = Price per share ÷ Earnings per share
MCGN Price-Earnings Ratio = £4.9 ÷ £0.164 = 29.9x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MCGN, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since MCGN’s P/E of 29.9x is lower than its industry peers (30.4x), it means that investors are paying less than they should for each dollar of MCGN’s earnings. As such, our analysis shows that MCGN represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that MCGN is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to MCGN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MCGN, 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 MCGN to are fairly valued by the market. If this is violated, MCGN’s P/E may be lower than its peers as they are actually overvalued by investors.
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.
