In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
United Energy Group Limited (HKG:467) is trading with a trailing P/E of 27.2, which is higher than the industry average of 11.8. 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.
See our latest analysis for United Energy Group
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 467
Price-Earnings Ratio = Price per share ÷ Earnings per share
467 Price-Earnings Ratio = HK$1.58 ÷ HK$0.0581 = 27.2x
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 467, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since 467’s P/E of 27.2 is higher than its industry peers (11.8), it means that investors are paying more for each dollar of 467’s earnings. This multiple is a median of profitable companies of 24 Oil and Gas companies in HK including Chinese People Holdings, JTF International Holdings and Yanzhou Coal Mining. You could also say that the market is suggesting that 467 is a stronger business than the average comparable company.
Assumptions to watch out for
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to 467. If this isn’t the case, the difference in P/E could be due to other factors. For example, United Energy Group Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 467 are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.