The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Art Group Holdings Limited (HKG:565) trades with a trailing P/E of 8.6, which is higher than the industry average of 5.8. While this might not seem positive, 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.
View our latest analysis for Art Group Holdings
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 565
Price-Earnings Ratio = Price per share ÷ Earnings per share
565 Price-Earnings Ratio = HK$0.33 ÷ HK$0.0376 = 8.6x
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 565, 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 565’s P/E of 8.6 is higher than its industry peers (5.8), it means that investors are paying more for each dollar of 565’s earnings. This multiple is a median of profitable companies of 25 Real Estate companies in HK including Fullsun International Holdings Group, Chinney Investments and Top Spring International Holdings. You could think of it like this: the market is pricing 565 as if it is a stronger company than the average of its industry group.
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 565. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where Art Group Holdings 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 565 may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.