Genscript Biotech Corporation (SEHK:1548) trades with a trailing P/E of 145.5x, which is higher than the industry average of 37.7x. While 1548 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Genscript Biotech
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for 1548
Price per share = $2.4
Earnings per share = $0.017
∴ Price-Earnings Ratio = $2.4 ÷ $0.017 = 145.5x
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 1548, 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 it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
1548’s P/E of 145.5x is higher than its industry peers (37.7x), which implies that each dollar of 1548’s earnings is being overvalued by investors. Therefore, according to this analysis, 1548 is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your 1548 shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to 1548. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing riskier firms with 1548, then 1548’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with 1548. In this case, 1548’s P/E would be higher since investors would also reward 1548’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing 1548 to are fairly valued by the market. If this assumption is violated, 1548's P/E may be higher than its peers because its peers are actually undervalued by investors.
What this means for you:
Since you may have already conducted your due diligence on 1548, the overvaluation of the stock may mean it is a good time to reduce 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. 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 highly recommend you to complete your research by taking a look at the following:
- 1. Future Outlook: What are well-informed industry analysts predicting for 1548’s future growth? Take a look at our free research report of analyst consensus for 1548’s outlook.
- 2. Financial Health: Is 1548’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- 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.