Luoyang Glass Company Limited (SEHK:1108) is currently trading at a trailing P/E of 18.2x, which is higher than the industry average of 16.5x. While this makes 1108 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. Check out our latest analysis for Luoyang Glass

Breaking down the P/E ratio

P/E is a popular ratio used for relative valuation. 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 1108

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

1108 Price-Earnings Ratio = CN¥2.92 ÷ CN¥0.16 = 18.2x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 1108, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since 1108’s P/E of 18.2x is higher than its industry peers (16.5x), it means that investors are paying more than they should for each dollar of 1108’s earnings. Therefore, according to this analysis, 1108 is an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your 1108 shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 1108. 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 1108, 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 1108 to are fairly valued by the market. If this does not hold, there is a possibility that 1108’s P/E is lower because our peer group is 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.