I am writing today to help inform people who are new to the stock market and want to begin learning the link between CIMC-TianDa Holdings Company Limited (HKG:445)’s fundamentals and stock market performance.
CIMC-TianDa Holdings Company Limited (HKG:445) trades with a trailing P/E of 1.7x, which is higher than the industry average of 15.1x. While 445 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 CIMC-TianDa Holdings
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 445
Price per share = SGD0.061
Earnings per share = SGD0.0360
∴ Price-Earnings Ratio = SGD0.061 ÷ SGD0.0360 = 1.7x
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 445, 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.
Since 445’s P/E of 1.7x is lower than its industry peers (15.1x), it means that investors are paying less than they should for each dollar of 445’s earnings. As such, our analysis shows that 445 represents an under-priced stock.
A few caveats
However, before you rush out to sell your 445 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 445. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with 445, then 445’s P/E would naturally be higher since investors would reward 445’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with 445, 445’s P/E would again be higher since investors would reward 445’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing 445 to are fairly valued by the market. If this assumption is violated, 445’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 445, the undervaluation of the stock may mean it is a good time to top up on 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 445’s future growth? Take a look at our free research report of analyst consensus for 445’s outlook.
- Financial Health: Is 445’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.