Hengan International Group Company Limited (SEHK:1044) trades with a trailing P/E of 20.8x, which is higher than the industry average of 20.5x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. 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 Hengan International Group
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 1044
Price-Earnings Ratio = Price per share ÷ Earnings per share
1044 Price-Earnings Ratio = CN¥60.99 ÷ CN¥2.939 = 20.8x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 1044, 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. 1044’s P/E of 20.8x is higher than its industry peers (20.5x), which implies that each dollar of 1044’s earnings is being overvalued by investors. As such, our analysis shows that 1044 represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your 1044 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 1044, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 1044, 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 1044 to are fairly valued by the market. If this is violated, 1044’s P/E may be lower than its peers as they are actually overvalued by investors.
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.