This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
M1 Limited (SGX:B2F) trades with a trailing P/E of 11.3x, which is lower than the industry average of 12.7x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for M1
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 B2F
Price-Earnings Ratio = Price per share ÷ Earnings per share
B2F Price-Earnings Ratio = SGD1.63 ÷ SGD0.144 = 11.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to B2F, 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. B2F’s P/E of 11.3 is lower than its industry peers (12.7), which implies that each dollar of B2F’s earnings is being undervalued by investors. Since the Wireless Telecom sector in SG is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as Ace Achieve Infocom, SEVAK and StarHub. One could put it like this: the market is pricing B2F as if it is a weaker company than the average company in its industry.
A few caveats
However, 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 B2F, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with B2F, 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 B2F to are fairly valued by the market. If this does not hold true, B2F’s lower P/E ratio may be because firms in our peer group are overvalued by the market.