The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in Affluent Foundation Holdings Limited (HKG:1757).
Affluent Foundation Holdings Limited (HKG:1757) is trading with a trailing P/E of 24.7x, which is higher than the industry average of 13.4x. While 1757 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for Affluent Foundation Holdings
What you need to know about 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for 1757
Price per share = HK$0.44
Earnings per share = HK$0.0178
∴ Price-Earnings Ratio = HK$0.44 ÷ HK$0.0178 = 24.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 1757, 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.
At 24.7x, 1757’s P/E is higher than its industry peers (13.4x). This implies that investors are overvaluing each dollar of 1757’s earnings. This multiple is a median of profitable companies of 25 Construction companies in HK including PYI, Hanison Construction Holdings and HPC Holdings. Therefore, according to this analysis, 1757 is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your 1757 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 1757. 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 1757, then investors would naturally value 1757 at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with 1757, investors would also value 1757 at a higher price since it is a higher growth investment. Both scenarios would explain why 1757 has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing 1757 to are fairly valued by the market. If this does not hold, there is a possibility that 1757’s P/E is higher because firms in our peer group are being undervalued by the market.
What this means for you:
Since you may have already conducted your due diligence on 1757, 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:
- Future Outlook: What are well-informed industry analysts predicting for 1757’s future growth? Take a look at our free research report of analyst consensus for 1757’s outlook.
- Financial Health: Is 1757’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.
- 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.