In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Feishang Anthracite Resources Limited (HKG:1738) is trading with a trailing P/E of 5.8x, which is lower than the industry average of 11.4x. While this makes 1738 appear like a great stock to buy, 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.
Check out our latest analysis for Feishang Anthracite Resources
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. 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 1738
Price-Earnings Ratio = Price per share ÷ Earnings per share
1738 Price-Earnings Ratio = CN¥0.79 ÷ CN¥0.138 = 5.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 1738, 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. 1738’s P/E of 5.8 is lower than its industry peers (11.4), which implies that each dollar of 1738’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Oil and Gas companies in HK including Chinese People Holdings, JTF International Holdings and Kinetic Mines and Energy. One could put it like this: the market is pricing 1738 as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 1738. 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 1738, 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 1738 to are fairly valued by the market. If this is violated, 1738’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 add more of 1738 to your portfolio. 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 highly recommend you to complete your research by taking a look at the following: