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 Hua Long Jin Kong Company Limited (HKG:1682)’s fundamentals and stock market performance.
Hua Long Jin Kong Company Limited (HKG:1682) is currently trading at a trailing P/E of 42.1x, which is higher than the industry average of 12.8x. While 1682 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. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View out our latest analysis for Hua Long Jin Kong
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 1682
Price per share = HK$0.60
Earnings per share = HK$0.0142
∴ Price-Earnings Ratio = HK$0.60 ÷ HK$0.0142 = 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. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 1682, such as company lifetime and products sold. 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.
1682’s P/E of 42.1x is higher than its industry peers (12.8x), which implies that each dollar of 1682’s earnings is being overvalued by investors. As such, our analysis shows that 1682 represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your 1682 shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to 1682. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared riskier firms with 1682, then investors would naturally value 1682 at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with 1682, investors would also value 1682 at a higher price since it is a higher growth investment. Both scenarios would explain why 1682 has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing 1682 to are fairly valued by the market. If this assumption is violated, 1682’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 1682, 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:
- Financial Health: Is 1682’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.
- Past Track Record: Has 1682 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 1682’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.