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Leader Environmental Technologies Limited (SGX:LS9) is currently trading at a trailing P/E of 8.6x, which is lower than the industry average of 14x. While this makes LS9 appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Leader Environmental Technologies
Demystifying 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 LS9
Price-Earnings Ratio = Price per share ÷ Earnings per share
LS9 Price-Earnings Ratio = CN¥0.19 ÷ CN¥0.022 = 8.6x
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 LS9, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 8.6x, LS9’s P/E is lower than its industry peers (14x). This implies that investors are undervaluing each dollar of LS9’s earnings. As such, our analysis shows that LS9 represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that LS9 is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to LS9, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with LS9, 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 LS9 to are fairly valued by the market. If this does not hold true, LS9’s lower P/E ratio may be because firms in our peer group are 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.