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This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Okura Holdings Limited (HKG:1655) is currently trading at a trailing P/E of 11.1x, which is lower than the industry average of 14.7x. While 1655 might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for Okura Holdings
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 1655
Price-Earnings Ratio = Price per share ÷ Earnings per share
1655 Price-Earnings Ratio = ¥16.47 ÷ ¥1.486 = 11.1x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 1655, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since 1655’s P/E of 11.1 is lower than its industry peers (14.7), it means that investors are paying less for each dollar of 1655’s earnings. This multiple is a median of profitable companies of 24 Hospitality companies in HK including Shun Ho Holdings, Shun Ho Property Investments and Capital Estate. You can think of it like this: the market is suggesting that 1655 is a weaker business than the average comparable company.
Assumptions to be aware of
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 1655, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 1655, 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 1655 to are fairly valued by the market. If this does not hold, there is a possibility that 1655’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on 1655, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following: