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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Hong Kong Economic Times Holdings Limited (HKG:423) is trading with a trailing P/E of 8.4x, which is lower than the industry average of 13.1x. While this makes 423 appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 Hong Kong Economic Times 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. 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 423
Price-Earnings Ratio = Price per share ÷ Earnings per share
423 Price-Earnings Ratio = HK$1.38 ÷ HK$0.165 = 8.4x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 423, 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. At 8.4, 423’s P/E is lower than its industry peers (13.1). This implies that investors are undervaluing each dollar of 423’s earnings. This multiple is a median of profitable companies of 24 Media companies in HK including Orange Sky Golden Harvest Entertainment (Holdings), CMMB Vision Holdings and Dahe Media. One could put it like this: the market is pricing 423 as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to 423. 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 423, 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 423 to are fairly valued by the market. If this does not hold, there is a possibility that 423’s P/E is lower because our peer group is overvalued by the market.