In This Article:
I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
China Minsheng DIT Group Limited (HKG:726) trades with a trailing P/E of 10.9, which is higher than the industry average of 5.5. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
See our latest analysis for China Minsheng DIT Group
Breaking down 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 726
Price-Earnings Ratio = Price per share ÷ Earnings per share
726 Price-Earnings Ratio = HK$0.15 ÷ HK$0.0138 = 10.9x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 726, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 10.9, 726’s P/E is higher than its industry peers (5.5). This implies that investors are overvaluing each dollar of 726’s earnings. This multiple is a median of profitable companies of 25 Real Estate companies in HK including Chinney Investments, Top Spring International Holdings and Hon Kwok Land Investment Company. You could also say that the market is suggesting that 726 is a stronger business than the average comparable company.
A few caveats
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to 726. If this isn’t the case, the difference in P/E could be due to other factors. For example, if China Minsheng DIT Group Limited is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 726 are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
Since you may have already conducted your due diligence on 726, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. 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: