HLH Group Limited (SGX:H27) is trading with a trailing P/E of 6.2x, which is lower than the industry average of 12.6x. 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for HLH Group

What you need to know about the P/E ratio

P/E is often used for relative valuation since earnings power is a chief 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 H27

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

H27 Price-Earnings Ratio = SGD0.01 ÷ SGD0.001 = 6.2x

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 H27, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. H27’s P/E of 6.2x is lower than its industry peers (12.6x), which implies that each dollar of H27’s earnings is being undervalued by investors. Therefore, according to this analysis, H27 is an under-priced stock.

Assumptions to watch out for

However, before you rush out to buy H27, 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 H27, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with H27, 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 H27 to are fairly valued by the market. If this is violated, H27’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.