Newgen Software Technologies Limited (NSEI:NEWGEN) is trading with a trailing P/E of 23.1x, which is higher than the industry average of 18.6x. While this makes NEWGEN 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 Newgen Software Technologies
Demystifying 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. 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 NEWGEN
Price per share = ₹244.3
Earnings per share = ₹10.564
∴ Price-Earnings Ratio = ₹244.3 ÷ ₹10.564 = 23.1x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to NEWGEN, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.
NEWGEN’s P/E of 23.1x is higher than its industry peers (18.6x), which implies that each dollar of NEWGEN’s earnings is being overvalued by investors. Therefore, according to this analysis, NEWGEN is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that NEWGEN should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to NEWGEN. 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 NEWGEN, then NEWGEN’s P/E would naturally be higher since investors would reward NEWGEN’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with NEWGEN, NEWGEN’s P/E would again be higher since investors would reward NEWGEN’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing NEWGEN to are fairly valued by the market. If this does not hold, there is a possibility that NEWGEN’s P/E is higher because firms in our peer group are being undervalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to NEWGEN. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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:
- Financial Health: Is NEWGEN’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.
- Valuation: What is NEWGEN worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether NEWGEN is currently mispriced by the market.
- 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.
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.
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