This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between ChemoCentryx Inc (NASDAQ:CCXI)’s fundamentals and stock market performance.
ChemoCentryx Inc (NASDAQ:CCXI) is trading with a trailing P/E of 42.1x, which is higher than the industry average of 28.2x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. 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. View out our latest analysis for ChemoCentryx
Breaking down the Price-Earnings 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for CCXI
Price per share = $12.52
Earnings per share = $0.297
∴ Price-Earnings Ratio = $12.52 ÷ $0.297 = 42.1x
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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to CCXI, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.
CCXI’s P/E of 42.1x is higher than its industry peers (28.2x), which implies that each dollar of CCXI’s earnings is being overvalued by investors. As such, our analysis shows that CCXI represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your CCXI shares, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to CCXI. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with CCXI, then investors would naturally value CCXI at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with CCXI, investors would also value CCXI at a higher price since it is a higher growth investment. Both scenarios would explain why CCXI has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing CCXI to are fairly valued by the market. If this assumption is violated, CCXI’s P/E may be higher than its peers because its peers are actually undervalued by investors.
What this means for you:
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 CCXI. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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:
- Future Outlook: What are well-informed industry analysts predicting for CCXI’s future growth? Take a look at our free research report of analyst consensus for CCXI’s outlook.
- Past Track Record: Has CCXI 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 CCXI’s historicals for more clarity.
- 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.