Is It Time To Buy SciGen Ltd (ASX:SIE) Based Off Its PE Ratio?
SciGen Ltd (ASX:SIE) is trading with a trailing P/E of 10x, which is lower than the industry average of 31.3x. While this makes SIE appear like a great stock to buy, 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 SciGen
Demystifying 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 dollar of the company’s earnings.
P/E Calculation for SIE
Price-Earnings Ratio = Price per share ÷ Earnings per share
SIE Price-Earnings Ratio = 0.05 ÷ 0.004 = 10x
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 SIE, 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 SIE's P/E of 10x is lower than its industry peers (31.3x), it means that investors are paying less than they should for each dollar of SIE's earnings. As such, our analysis shows that SIE represents an under-priced stock.
A few caveats
However, before you rush out to buy SIE, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to SIE. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with SIE, 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 SIE to are fairly valued by the market. If this does not hold true, SIE’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on SIE, the undervaluation of the stock may mean it is a good time to top up on 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 SIE, 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 SciGen 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.
