ETS Group Limited (SEHK:8031) trades with a trailing P/E of 105.4x, which is higher than the industry average of 19.4x. While 8031 might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for ETS Group

Breaking down the Price-Earnings ratio

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 8031

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

8031 Price-Earnings Ratio = HK$0.97 ÷ HK$0.009 = 105.4x

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 8031, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 105.4x, 8031’s P/E is higher than its industry peers (19.4x). This implies that investors are overvaluing each dollar of 8031’s earnings. As such, our analysis shows that 8031 represents an over-priced stock.

A few caveats

Before you jump to the conclusion that 8031 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to 8031. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with 8031, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing 8031 to are fairly valued by the market. If this does not hold, there is a possibility that 8031’s P/E is lower because our peer group is 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.