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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 the link between Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874)’s fundamentals and stock market performance.
Guangzhou Baiyunshan Pharmaceutical Holdings Company Limited (HKG:874) is currently trading at a trailing P/E of 18.8x, which is lower than the industry average of 21.2x. While 874 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Guangzhou Baiyunshan Pharmaceutical Holdings
Breaking down 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 874
Price-Earnings Ratio = Price per share ÷ Earnings per share
874 Price-Earnings Ratio = CN¥28.78 ÷ CN¥1.527 = 18.8x
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 874, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since 874’s P/E of 18.8x is lower than its industry peers (21.2x), it means that investors are paying less than they should for each dollar of 874’s earnings. Therefore, according to this analysis, 874 is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy 874, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to 874, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 874, 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 874 to are fairly valued by the market. If this does not hold true, 874’s lower P/E ratio may be because firms in our peer group are overvalued by the market.