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This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
ValueMax Group Limited (SGX:T6I) is currently trading at a trailing P/E of 7.5x, which is lower than the industry average of 15.1x. Although some investors may jump to the conclusion that this is a great buying opportunity, 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.
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Breaking down the Price-Earnings ratio
P/E is a popular ratio used for relative valuation. 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 T6I
Price-Earnings Ratio = Price per share ÷ Earnings per share
T6I Price-Earnings Ratio = SGD0.28 ÷ SGD0.0376 = 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 T6I, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. T6I’s P/E of 7.5 is lower than its industry peers (15.1), which implies that each dollar of T6I’s earnings is being undervalued by investors. Since the Consumer Finance sector in SG is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as Sing Investments & Finance, Hong Leong Finance and Singapura Finance. You can think of it like this: the market is suggesting that T6I is a weaker business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to T6I, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with T6I, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing T6I to are fairly valued by the market. If this is violated, T6I’s P/E may be lower than its peers as they are actually overvalued by investors.