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This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Grand T G Gold Holdings Limited (HKG:8299) is currently trading at a trailing P/E of 7.6x, which is lower than the industry average of 8.1x. 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. 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.
View our latest analysis for Grand T G Gold Holdings
Breaking down the Price-Earnings 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 8299
Price-Earnings Ratio = Price per share ÷ Earnings per share
8299 Price-Earnings Ratio = HK$0.012 ÷ HK$0.00158 = 7.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 8299, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 7.6, 8299’s P/E is lower than its industry peers (8.1). This implies that investors are undervaluing each dollar of 8299’s earnings. This multiple is a median of profitable companies of 24 Metals and Mining companies in HK including IRC, Hong Kong Finance Investment Holding Group and E-Commodities Holdings. One could put it like this: the market is pricing 8299 as if it is a weaker company than the average company in its industry.
A few caveats
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 8299, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with 8299, 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 8299 to are fairly valued by the market. If this is violated, 8299’s P/E may be lower than its peers as they are actually overvalued by investors.