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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Sunwah Kingsway Capital Holdings Limited (HKG:188) trades with a trailing P/E of 17.8, which is higher than the industry average of 9.8. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Check out our latest analysis for Sunwah Kingsway Capital Holdings
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 188
Price-Earnings Ratio = Price per share ÷ Earnings per share
188 Price-Earnings Ratio = HK$0.061 ÷ HK$0.00344 = 17.8x
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 188, 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. 188’s P/E of 17.8 is higher than its industry peers (9.8), which implies that each dollar of 188’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Capital Markets companies in HK including Freeman FinTech, Oriental Explorer Holdings and Emperor Capital Group. You could also say that the market is suggesting that 188 is a stronger business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to 188. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Sunwah Kingsway Capital Holdings Limited is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 188 are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.