In This Article:
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Chinasoft International Limited (HKG:354) is trading with a trailing P/E of 13, which is close to the industry average of 12.4. 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 explain what the P/E ratio is as well as what you should look out for when using it.
See our latest analysis for Chinasoft International
Demystifying 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 354
Price-Earnings Ratio = Price per share ÷ Earnings per share
354 Price-Earnings Ratio = CN¥3.66 ÷ CN¥0.282 = 13x
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 354, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Chinasoft International Limited (HKG:354) trades on a trailing P/E of 13. This isn’t too far from the industry average (which is 12.4). This multiple is a median of profitable companies of 24 IT companies in HK including Green Leader Holdings Group, Sino-i Technology and CCID Consulting. One could put it like this: the market is pricing 354 as if it is roughly average for its industry.
A few caveats
However, you should be aware that this analysis makes certain assumptions. The first is that our “similar companies” are actually similar to 354. If not, the difference in P/E might be a result of other factors. For example, Chinasoft International Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 354 are not 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.
What this means for you:
Since you may have already conducted your due diligence on 354, 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: