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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 begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
APT Satellite Holdings Limited (HKG:1045) is currently trading at a trailing P/E of 4.4x, which is lower than the industry average of 14.1x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for APT Satellite Holdings
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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.
P/E Calculation for 1045
Price-Earnings Ratio = Price per share ÷ Earnings per share
1045 Price-Earnings Ratio = HK$2.58 ÷ HK$0.582 = 4.4x
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 1045, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. 1045’s P/E of 4.4 is lower than its industry peers (14.1), which implies that each dollar of 1045’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 10 Telecom companies in HK including Great Wall Belt & Road Holdings, Asia Satellite Telecommunications Holdings and CITIC Telecom International Holdings. You can think of it like this: the market is suggesting that 1045 is a weaker business than the average comparable company.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to 1045. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with 1045, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing 1045 to are fairly valued by the market. If this does not hold true, 1045’s lower P/E ratio may be because firms in our peer group are overvalued by the market.