In This Article:
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
China Overseas Land & Investment Limited (HKG:688) is trading with a trailing P/E of 6.1, which is higher than the industry average of 5.6. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for China Overseas Land & Investment
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 688
Price-Earnings Ratio = Price per share ÷ Earnings per share
688 Price-Earnings Ratio = HK$23.5 ÷ HK$3.864 = 6.1x
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 688, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. 688’s P/E of 6.1 is higher than its industry peers (5.6), which implies that each dollar of 688’s earnings is being overvalued by investors. 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 688 is a stronger business than the average comparable company.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to 688. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where China Overseas Land & Investment 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 688 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.