Is NCC Limited's (NSE:NCC) PE Ratio A Signal To Sell For Investors?

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

NCC Limited (NSE:NCC) is currently trading at a trailing P/E of 34.4x, which is higher than the industry average of 19.8x. While this makes NCC 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for NCC

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.

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 NCC, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.

At 34.4x, NCC’s P/E is higher than its industry peers (19.8x). This implies that investors are overvaluing each dollar of NCC’s earnings. As such, our analysis shows that NCC represents an over-priced stock.

A few caveats

While our conclusion might prompt you to sell your NCC shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to NCC. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with NCC, then NCC’s P/E would naturally be higher since investors would reward NCC’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with NCC, NCC’s P/E would again be higher since investors would reward NCC’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing NCC to are fairly valued by the market. If this assumption is violated, NCC'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 NCC, 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 urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for NCC’s future growth? Take a look at our free research report of analyst consensus for NCC’s outlook.
2. Past Track Record: Has NCC 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 NCC'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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.