C-MER Eye Care Holdings Limited (SEHK:3309) trades with a trailing P/E of 187.1x, which is higher than the industry average of 33.3x. 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for C-MER Eye Care Holdings
Demystifying 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 3309
Price per share = HK$13.26
Earnings per share = HK$0.071
∴ Price-Earnings Ratio = HK$13.26 ÷ HK$0.071 = 187.1x
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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 3309, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use below. 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 187.1x, 3309’s P/E is higher than its industry peers (33.3x). This implies that investors are overvaluing each dollar of 3309’s earnings. As such, our analysis shows that 3309 represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your 3309 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 3309. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing riskier firms with 3309, then 3309’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 3309. In this case, 3309’s P/E would be higher since investors would also reward 3309’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing 3309 to are fairly valued by the market. If this does not hold, there is a possibility that 3309’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 3309. 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:
- 1. Financial Health: Is 3309’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.
- 2. Valuation: What is 3309 worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether 3309 is currently mispriced by the market.
- 3. 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.