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 begin learning the link between Valuetronics Holdings Limited (SGX:BN2)’s fundamentals and stock market performance.
Valuetronics Holdings Limited (SGX:BN2) is trading with a trailing P/E of 9.4x, which is higher than the industry average of 9.3x. While this makes BN2 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. Today, 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 Valuetronics Holdings
Breaking down 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 BN2
Price per share = HK$4.52
Earnings per share = HK$0.481
∴ Price-Earnings Ratio = HK$4.52 ÷ HK$0.481 = 9.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 BN2, such as capital structure and profitability. 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.
At 9.4x, BN2’s P/E is higher than its industry peers (9.3x). This implies that investors are overvaluing each dollar of BN2’s earnings. As such, our analysis shows that BN2 represents an over-priced stock.
A few caveats
Before you jump to the conclusion that BN2 should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to BN2. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with BN2, then investors would naturally value BN2 at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with BN2, investors would also value BN2 at a higher price since it is a higher growth investment. Both scenarios would explain why BN2 has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing BN2 to are fairly valued by the market. If this does not hold, there is a possibility that BN2’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 BN2. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for BN2’s future growth? Take a look at our free research report of analyst consensus for BN2’s outlook.
- Past Track Record: Has BN2 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 BN2’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.