KSH Holdings Limited (SGX:ER0) trades with a trailing P/E of 11.5x, which is lower than the industry average of 12.5x. 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. Today, 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 KSH Holdings

What you need to know about 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 ER0

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

ER0 Price-Earnings Ratio = SGD0.7 ÷ SGD0.06 = 11.5x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 ER0, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 11.5x, ER0’s P/E is lower than its industry peers (12.5x). This implies that investors are undervaluing each dollar of ER0’s earnings. Therefore, according to this analysis, ER0 is an under-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to buy ER0 immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to ER0. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with ER0, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing ER0 to are fairly valued by the market. If this does not hold, there is a possibility that ER0’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.