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Fullshare Holdings Limited (SEHK:607) is currently trading at a trailing P/E of 70.8x, which is higher than the industry average of 7.2x. While this makes 607 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Fullshare Holdings
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 607
Price-Earnings Ratio = Price per share ÷ Earnings per share
607 Price-Earnings Ratio = CN¥3.49 ÷ CN¥0.049 = 70.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 607, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since 607’s P/E of 70.8x is higher than its industry peers (7.2x), it means that investors are paying more than they should for each dollar of 607’s earnings. Therefore, according to this analysis, 607 is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your 607 shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 607. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with 607, 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 607 to are fairly valued by the market. If this does not hold, there is a possibility that 607’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.