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China Shineway Pharmaceutical Group Limited (SEHK:2877) trades with a trailing P/E of 21.8x, which is higher than the industry average of 20.6x. While this makes 2877 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 Shineway Pharmaceutical Group
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 2877
Price-Earnings Ratio = Price per share ÷ Earnings per share
2877 Price-Earnings Ratio = CN¥11.91 ÷ CN¥0.546 = 21.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 2877, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since 2877’s P/E of 21.8x is higher than its industry peers (20.6x), it means that investors are paying more than they should for each dollar of 2877’s earnings. As such, our analysis shows that 2877 represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your 2877 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 2877, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with 2877, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing 2877 to are fairly valued by the market. If this does not hold true, 2877’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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.