Syncona Limited (LSE:SYNC) is currently trading at a trailing P/E of 11.4x, which is lower than the industry average of 16.4x. 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for SYNC
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 SYNC
Price-Earnings Ratio = Price per share ÷ Earnings per share
SYNC Price-Earnings Ratio = 1.91 ÷ 0.167 = 11.4x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SYNC, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since SYNC's P/E of 11.4x is lower than its industry peers (16.4x), it means that investors are paying less than they should for each dollar of SYNC's earnings. As such, our analysis shows that SYNC represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy SYNC immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SYNC. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with SYNC, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing SYNC to are fairly valued by the market. If this does not hold true, SYNC’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? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of SYNC to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.