Riverstone Holdings Limited (SGX:AP4) trades with a trailing P/E of 17.7x, which is higher than the industry average of 13.8x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Riverstone Holdings

What you need to know about the P/E ratio

The P/E ratio is one of many ratios used in 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 AP4

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

AP4 Price-Earnings Ratio = MYR3.08 ÷ MYR0.174 = 17.7x

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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as AP4, 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 17.7x, AP4’s P/E is higher than its industry peers (13.8x). This implies that investors are overvaluing each dollar of AP4’s earnings. As such, our analysis shows that AP4 represents an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your AP4 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to AP4, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with AP4, 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 AP4 to are fairly valued by the market. If this is violated, AP4’s P/E may be lower than its peers as they are actually overvalued by investors.

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.