In This Article:
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Oxley Holdings Limited (SGX:5UX) is currently trading at a trailing P/E of 4.5x, which is lower than the industry average of 9.7x. While this makes 5UX appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 Oxley Holdings
Demystifying 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 5UX
Price-Earnings Ratio = Price per share ÷ Earnings per share
5UX Price-Earnings Ratio = SGD0.33 ÷ SGD0.0727 = 4.5x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 5UX, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 4.5, 5UX’s P/E is lower than its industry peers (9.7). This implies that investors are undervaluing each dollar of 5UX’s earnings. This multiple is a median of profitable companies of 24 Real Estate companies in SG including Heeton Holdings, Hong Fok and CWG International. One could put it like this: the market is pricing 5UX 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. Firstly, our peer group contains companies that are similar to 5UX. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with 5UX, 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 5UX to are fairly valued by the market. If this does not hold true, 5UX’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of 5UX to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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: