Vistar Holdings Limited (SEHK:8535) is trading with a trailing P/E of 18.1x, which is higher than the industry average of 10.6x. While 8535 might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 Vistar Holdings

Breaking down the Price-Earnings ratio

The P/E ratio is one of many ratios used in 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 8535

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

8535 Price-Earnings Ratio = HK$0.14 ÷ HK$0.008 = 18.1x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 8535, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. 8535’s P/E of 18.1x is higher than its industry peers (10.6x), which implies that each dollar of 8535’s earnings is being overvalued by investors. Therefore, according to this analysis, 8535 is an over-priced stock.

A few caveats

Before you jump to the conclusion that 8535 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to 8535. 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 8535, 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 8535 to are fairly valued by the market. If this does not hold, there is a possibility that 8535’s P/E is lower because our peer group is 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.