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Sichuan Expressway Company Limited (SEHK:107) is currently trading at a trailing P/E of 7.5x, which is lower than the industry average of 9.3x. While 107 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 break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Sichuan Expressway
Demystifying 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 107
Price-Earnings Ratio = Price per share ÷ Earnings per share
107 Price-Earnings Ratio = CN¥2.29 ÷ CN¥0.305 = 7.5x
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 107, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. 107’s P/E of 7.5x is lower than its industry peers (9.3x), which implies that each dollar of 107’s earnings is being undervalued by investors. As such, our analysis shows that 107 represents an under-priced stock.
A few caveats
However, before you rush out to buy 107, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to 107. 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 107, 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 107 to are fairly valued by the market. If this does not hold true, 107’s lower P/E ratio may be because firms in our peer group are 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.