In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Hotel Properties Limited (SGX:H15) is currently trading at a trailing P/E of 8.8x, which is lower than the industry average of 14.9x. While H15 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. 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.
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Breaking down the P/E 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 H15
Price-Earnings Ratio = Price per share ÷ Earnings per share
H15 Price-Earnings Ratio = SGD3.7 ÷ SGD0.419 = 8.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as H15, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. H15’s P/E of 8.8 is lower than its industry peers (14.9), which implies that each dollar of H15’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 15 Hospitality companies in SG including HL Global Enterprises, Stamford Land and Sakae Holdings. One could put it like this: the market is pricing H15 as if it is a weaker company than the average company in its industry.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to H15, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with H15, 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 H15 to are fairly valued by the market. If this does not hold, there is a possibility that H15’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of H15 to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following: