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This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Alltronics Holdings Limited (HKG:833) trades with a trailing P/E of 14.2, which is higher than the industry average of 12.6. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. 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 Alltronics Holdings
Breaking down the Price-Earnings 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.
P/E Calculation for 833
Price-Earnings Ratio = Price per share ÷ Earnings per share
833 Price-Earnings Ratio = HK$1.34 ÷ HK$0.0943 = 14.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 833, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 14.2, 833’s P/E is higher than its industry peers (12.6). This implies that investors are overvaluing each dollar of 833’s earnings. This multiple is a median of profitable companies of 24 Consumer Durables companies in HK including China Baofeng (International), Samson Holding and Kin Yat Holdings. You could think of it like this: the market is pricing 833 as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to 833. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Alltronics Holdings Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 833 are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.