Sicagen India Limited (NSEI:SICAGEN) is currently trading at a trailing P/E of 127.6x, which is higher than the industry average of 21.9x. While SICAGEN 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 Sicagen India
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 SICAGEN
Price-Earnings Ratio = Price per share ÷ Earnings per share
SICAGEN Price-Earnings Ratio = ₹37 ÷ ₹0.29 = 127.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to SICAGEN, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 127.6x, SICAGEN’s P/E is higher than its industry peers (21.9x). This implies that investors are overvaluing each dollar of SICAGEN’s earnings. Therefore, according to this analysis, SICAGEN is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that SICAGEN should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to SICAGEN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SICAGEN, 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 SICAGEN to are fairly valued by the market. If this does not hold, there is a possibility that SICAGEN’s P/E is lower because our peer group is overvalued by the market.
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 SICAGEN. 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: