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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 learn about the link between company’s fundamentals and stock market performance.
Koda Ltd (SGX:BJZ) is trading with a trailing P/E of 7.9x, which is lower than the industry average of 15.7x. 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.
See our latest analysis for Koda
What you need to know about the P/E 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 BJZ
Price-Earnings Ratio = Price per share ÷ Earnings per share
BJZ Price-Earnings Ratio = $0.55 ÷ $0.0690 = 7.9x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as BJZ, 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. BJZ’s P/E of 7.9 is lower than its industry peers (15.7), which implies that each dollar of BJZ’s earnings is being undervalued by investors. Since the sector in is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as , and . You can think of it like this: the market is suggesting that BJZ is a weaker business than the average comparable company.
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 BJZ, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with BJZ, 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 BJZ to are fairly valued by the market. If this does not hold true, BJZ’s lower P/E ratio may be because firms in our peer group are overvalued by the market.