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 learn about the link between company’s fundamentals and stock market performance.
iFAST Corporation Ltd (SGX:AIY) is currently trading at a trailing P/E of 27.6x, which is higher than the industry average of 17.6x. 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. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 AIY
Price per share = SGD1.13
Earnings per share = SGD0.0409
∴ Price-Earnings Ratio = SGD1.13 ÷ SGD0.0409 = 27.6x
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 AIY, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 27.6x, AIY’s P/E is higher than its industry peers (17.6x). This implies that investors are overvaluing each dollar of AIY’s earnings. Since the Diversified Financial sector in SG is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as Pacific Century Regional Developments, IFS Capital and . Therefore, according to this analysis, AIY is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your AIY shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to AIY. 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 AIY, then AIY’s P/E would naturally be higher since investors would reward AIY’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with AIY, AIY’s P/E would again be higher since investors would reward AIY’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing AIY to are fairly valued by the market. If this does not hold, there is a possibility that AIY’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 AIY. 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 AIY’s future growth? Take a look at our free research report of analyst consensus for AIY’s outlook.
- Past Track Record: Has AIY 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 AIY’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 firstname.lastname@example.org.