Best Pacific International Holdings Limited (SEHK:2111) is currently trading at a trailing P/E of 10.2x, which is lower than the industry average of 13.2x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Best Pacific International Holdings

What you need to know about the P/E ratio

The P/E ratio is one of many ratios used in relative valuation. 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 2111

Price-Earnings Ratio = Price per share ÷ Earnings per share

2111 Price-Earnings Ratio = HK$3 ÷ HK$0.295 = 10.2x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 2111, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. 2111’s P/E of 10.2x is lower than its industry peers (13.2x), which implies that each dollar of 2111’s earnings is being undervalued by investors. Therefore, according to this analysis, 2111 is an under-priced stock.

A few caveats

Before you jump to the conclusion that 2111 is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to 2111, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 2111, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing 2111 to are fairly valued by the market. If this is violated, 2111’s P/E may be lower than its peers as they are actually overvalued by investors.

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 2111. 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:

1. Future Outlook: What are well-informed industry analysts predicting for 2111’s future growth? Take a look at our free research report of analyst consensus for 2111’s outlook.

2. Past Track Record: Has 2111 been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of 2111’s historicals for more clarity.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.