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Is It Time To Sell Neogen Corporation (NASDAQ:NEOG) Based Off Its PE Ratio?

This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Neogen Corporation (NASDAQ:NEOG)’s fundamentals and stock market performance.

Neogen Corporation (NASDAQ:NEOG) is currently trading at a trailing P/E of 73.6x, which is higher than the industry average of 37.8x. While this makes NEOG 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.

Breaking down the P/E ratio

P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 NEOG

Price-Earnings Ratio = Price per share ÷ Earnings per share

NEOG Price-Earnings Ratio = \$83.6 ÷ \$1.135 = 73.6x

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 NEOG, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since NEOG’s P/E of 73.6x is higher than its industry peers (37.8x), it means that investors are paying more than they should for each dollar of NEOG’s earnings. As such, our analysis shows that NEOG represents an over-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that NEOG should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to NEOG. 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 NEOG, 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 NEOG to are fairly valued by the market. If this is violated, NEOG’s P/E may be lower than its peers as they are actually overvalued by investors.

What this means for you:

If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in NEOG. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for NEOG’s future growth? Take a look at our free research report of analyst consensus for NEOG’s outlook.
2. Past Track Record: Has NEOG been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of NEOG’s historicals for more clarity.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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.