Sikko Industries Limited (NSEI:SIKKO) is currently trading at a trailing P/E of 39.9x, which is higher than the industry average of 24.2x. While this makes SIKKO 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Sikko Industries
Breaking down 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 SIKKO
Price-Earnings Ratio = Price per share ÷ Earnings per share
SIKKO Price-Earnings Ratio = ₹39.9 ÷ ₹1.001 = 39.9x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SIKKO, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 39.9x, SIKKO’s P/E is higher than its industry peers (24.2x). This implies that investors are overvaluing each dollar of SIKKO’s earnings. Therefore, according to this analysis, SIKKO is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that SIKKO 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 SIKKO, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with SIKKO, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing SIKKO to are fairly valued by the market. If this does not hold true, SIKKO’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 rebalance your portfolio and reduce your holdings in SIKKO. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in SIKKO, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.