Hang Lung Properties Limited (SEHK:101) trades with a trailing P/E of 12.8x, which is higher than the industry average of 9.1x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, 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. See our latest analysis for Hang Lung Properties
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for 101
Price-Earnings Ratio = Price per share ÷ Earnings per share
101 Price-Earnings Ratio = HK$20.1 ÷ HK$1.576 = 12.8x
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 101, 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. 101’s P/E of 12.8x is higher than its industry peers (9.1x), which implies that each dollar of 101’s earnings is being overvalued by investors. Therefore, according to this analysis, 101 is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your 101 shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to 101, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with 101, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing 101 to are fairly valued by the market. If this is violated, 101’s P/E may be lower than its peers as they are actually overvalued by investors.
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.