This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Harmonicare Medical Holdings Limited (HKG:1509).
Harmonicare Medical Holdings Limited (HKG:1509) is trading with a trailing P/E of 51.3x, which is higher than the industry average of 35.2x. While this makes 1509 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Harmonicare Medical Holdings
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 1509
Price per share = CN¥1.85
Earnings per share = CN¥0.0361
∴ Price-Earnings Ratio = CN¥1.85 ÷ CN¥0.0361 = 51.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 1509, 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 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 51.3x, 1509’s P/E is higher than its industry peers (35.2x). This implies that investors are overvaluing each dollar of 1509’s earnings. As such, our analysis shows that 1509 represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your 1509 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 1509. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with 1509, then 1509’s P/E would naturally be higher since investors would reward 1509’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with 1509, 1509’s P/E would again be higher since investors would reward 1509’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing 1509 to are fairly valued by the market. If this does not hold, there is a possibility that 1509’s P/E is higher because firms in our peer group are being undervalued by the market.
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 1509. 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:
- Financial Health: Is 1509’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 1509 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 1509’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.