Beijing Gas Blue Sky Holdings Limited (SGX:UQ7) is currently trading at a trailing P/E of 82.8x, which is higher than the industry average of 19.7x. While UQ7 might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, 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 Beijing Gas Blue Sky Holdings

What you need to know about the P/E ratio

A common ratio used for relative valuation is the P/E ratio. 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 UQ7

Price-Earnings Ratio = Price per share ÷ Earnings per share

UQ7 Price-Earnings Ratio = HK$0.57 ÷ HK$0.007 = 82.8x

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 UQ7, 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 UQ7’s P/E of 82.8x is higher than its industry peers (19.7x), it means that investors are paying more than they should for each dollar of UQ7’s earnings. Therefore, according to this analysis, UQ7 is an over-priced stock.

A few caveats

However, before you rush out to sell your UQ7 shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to UQ7, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with UQ7, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing UQ7 to are fairly valued by the market. If this does not hold true, UQ7’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

To help readers see pass 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.