Keong Hong Holdings Limited (SGX:5TT) is trading with a trailing P/E of 2.2x, which is lower than the industry average of 12.2x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Keong Hong Holdings

Breaking down the P/E 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 5TT

Price-Earnings Ratio = Price per share ÷ Earnings per share

5TT Price-Earnings Ratio = SGD0.59 ÷ SGD0.269 = 2.2x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 5TT, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 2.2x, 5TT’s P/E is lower than its industry peers (12.2x). This implies that investors are undervaluing each dollar of 5TT’s earnings. Therefore, according to this analysis, 5TT is an under-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to buy 5TT immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 5TT. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with 5TT, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing 5TT to are fairly valued by the market. If this does not hold true, 5TT’s lower P/E ratio may be because firms in our peer group are 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.