Hi-P International Limited (SGX:H17) is currently trading at a trailing P/E of 9.2x, which is lower than the industry average of 9.6x. While H17 might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Hi-P International
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.
P/E Calculation for H17
Price-Earnings Ratio = Price per share ÷ Earnings per share
H17 Price-Earnings Ratio = SGD1.41 ÷ SGD0.153 = 9.2x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to H17, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since H17’s P/E of 9.2x is lower than its industry peers (9.6x), it means that investors are paying less than they should for each dollar of H17’s earnings. As such, our analysis shows that H17 represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that H17 is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to H17. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with H17, 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 H17 to are fairly valued by the market. If this does not hold, there is a possibility that H17’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to H17. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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: