Green Build Technology Limited (SGX:Y06) is trading with a trailing P/E of 176.9x, which is higher than the industry average of 10.5x. While Y06 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. Today, 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 Green Build Technology
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 Y06
Price-Earnings Ratio = Price per share ÷ Earnings per share
Y06 Price-Earnings Ratio = CN¥0.83 ÷ CN¥0.005 = 176.9x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as Y06, 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. At 176.9x, Y06’s P/E is higher than its industry peers (10.5x). This implies that investors are overvaluing each dollar of Y06’s earnings. As such, our analysis shows that Y06 represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your Y06 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to Y06, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with Y06, 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 Y06 to are fairly valued by the market. If this does not hold, there is a possibility that Y06’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to Y06. 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.