International Entertainment Corporation (SEHK:1009) is trading with a trailing P/E of 97.4x, which is higher than the industry average of 6.6x. While this makes 1009 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for International Entertainment
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 1009
Price-Earnings Ratio = Price per share ÷ Earnings per share
1009 Price-Earnings Ratio = HK$2.24 ÷ HK$0.023 = 97.4x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 1009, 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 97.4x, 1009’s P/E is higher than its industry peers (6.6x). This implies that investors are overvaluing each dollar of 1009’s earnings. As such, our analysis shows that 1009 represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that 1009 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to 1009, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with 1009, 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 1009 to are fairly valued by the market. If this does not hold true, 1009’s lower P/E ratio may be because firms in our peer group are 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 1009. 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.