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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.
ANTA Sports Products Limited (HKG:2020) is trading with a trailing P/E of 23, which is higher than the industry average of 11.1. 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.
View our latest analysis for ANTA Sports Products
Demystifying 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.
P/E Calculation for 2020
Price-Earnings Ratio = Price per share ÷ Earnings per share
2020 Price-Earnings Ratio = CN¥30.73 ÷ CN¥1.334 = 23x
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 2020, 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 2020’s P/E of 23 is higher than its industry peers (11.1), it means that investors are paying more for each dollar of 2020’s earnings. This multiple is a median of profitable companies of 25 Luxury companies in HK including Victory City International Holdings, Hosa International and Continental Holdings. You could also say that the market is suggesting that 2020 is a stronger business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to 2020. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where ANTA Sports Products 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. We should also be aware that the stocks we are comparing to 2020 may not be 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.