In This Article:
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Frencken Group Limited (SGX:E28) is currently trading at a trailing P/E of 7.3x, which is lower than the industry average of 9.9x. While E28 might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
View our latest analysis for Frencken Group
Breaking down 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 E28
Price-Earnings Ratio = Price per share ÷ Earnings per share
E28 Price-Earnings Ratio = SGD0.42 ÷ SGD0.0574 = 7.3x
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 E28, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 7.3, E28’s P/E is lower than its industry peers (9.9). This implies that investors are undervaluing each dollar of E28’s earnings. This multiple is a median of profitable companies of 13 Machinery companies in SG including Grand Banks Yachts, Yangzijiang Shipbuilding (Holdings) and InnoTek. You can think of it like this: the market is suggesting that E28 is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to E28. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with E28, 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 E28 to are fairly valued by the market. If this does not hold true, E28’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 E28. 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: