In This Article:
I am writing today to help inform people who are new to the stock market and want to begin learning the link between Dongfang Electric Corporation Limited (HKG:1072)’s fundamentals and stock market performance.
Dongfang Electric Corporation Limited (HKG:1072) is trading with a trailing P/E of 14.2x, which is higher than the industry average of 12.2x. While this makes 1072 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View out our latest analysis for Dongfang Electric
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 1072
Price-Earnings Ratio = Price per share ÷ Earnings per share
1072 Price-Earnings Ratio = CN¥4.4 ÷ CN¥0.310 = 14.2x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 1072, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since 1072’s P/E of 14.2x is higher than its industry peers (12.2x), it means that investors are paying more than they should for each dollar of 1072’s earnings. Therefore, according to this analysis, 1072 is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your 1072 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 1072, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 1072, 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 1072 to are fairly valued by the market. If this is violated, 1072’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in 1072. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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: