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 start learning about core concepts of fundamental analysis on practical examples from today’s market.
Red Star Macalline Group Corporation Ltd (HKG:1528) trades with a trailing P/E of 5.9x, which is lower than the industry average of 6.5x. While 1528 might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
What you need to know about the P/E ratio
P/E is a popular ratio used for 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 1528
Price per share = CN¥6.95
Earnings per share = CN¥1.181
∴ Price-Earnings Ratio = CN¥6.95 ÷ CN¥1.181 = 5.9x
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 1528, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
1528’s P/E of 5.9x is lower than its industry peers (6.5x), which implies that each dollar of 1528’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 25 Real Estate companies in HK including Fullsun International Holdings Group, Redsun Properties Group and Top Spring International Holdings. Therefore, according to this analysis, 1528 is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy 1528 immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 1528. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with 1528, then investors would naturally value 1528 at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with 1528, investors would also value 1528 at a lower price since it is a lower growth investment. Both scenarios would explain why 1528 has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing 1528 to are fairly valued by the market. If this assumption is violated, 1528’s P/E may be lower than its peers because its peers are actually overvalued by investors.
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 add more of 1528 to your portfolio. 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:
- Future Outlook: What are well-informed industry analysts predicting for 1528’s future growth? Take a look at our free research report of analyst consensus for 1528’s outlook.
- Past Track Record: Has 1528 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 1528’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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.