I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Bisu Technology Group International Limited (HKG:1372) is currently trading at a trailing P/E of 23.3x, which is higher than the industry average of 13.3x. 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the Price-Earnings 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for 1372
Price per share = HK$4.4
Earnings per share = HK$0.189
∴ Price-Earnings Ratio = HK$4.4 ÷ HK$0.189 = 23.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against 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 1372, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use below. 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 23.3x, 1372’s P/E is higher than its industry peers (13.3x). This implies that investors are overvaluing each dollar of 1372’s earnings. This multiple is a median of profitable companies of 25 Construction companies in HK including PYI, HPC Holdings and Build King Holdings. As such, our analysis shows that 1372 represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your 1372 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 1372. 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 1372, then 1372’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 1372. In this case, 1372’s P/E would be higher since investors would also reward 1372’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing 1372 to are fairly valued by the market. If this does not hold, there is a possibility that 1372’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 1372. 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:
- Future Outlook: What are well-informed industry analysts predicting for 1372’s future growth? Take a look at our free research report of analyst consensus for 1372’s outlook.
- Past Track Record: Has 1372 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 1372’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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.