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Haw Par Corporation Limited (SGX:H02) trades with a trailing P/E of 21.9x, which is lower than the industry average of 23.6x. While H02 might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Haw Par
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 H02
Price-Earnings Ratio = Price per share ÷ Earnings per share
H02 Price-Earnings Ratio = SGD12.5 ÷ SGD0.571 = 21.9x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to H02, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. H02’s P/E of 21.9x is lower than its industry peers (23.6x), which implies that each dollar of H02’s earnings is being undervalued by investors. Therefore, according to this analysis, H02 is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy H02, 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 H02, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with H02, 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 H02 to are fairly valued by the market. If this does not hold, there is a possibility that H02’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.