Luxking Group Holdings Limited (SGX:BKK) trades with a trailing P/E of 5.8x, which is lower than the industry average of 14.7x. While BKK 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. Check out our latest analysis for Luxking Group Holdings

Breaking down 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 BKK

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

BKK Price-Earnings Ratio = CN¥1.87 ÷ CN¥0.322 = 5.8x

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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as BKK, 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. At 5.8x, BKK’s P/E is lower than its industry peers (14.7x). This implies that investors are undervaluing each dollar of BKK’s earnings. Therefore, according to this analysis, BKK is an under-priced stock.

Assumptions to watch out for

While our conclusion might prompt you to buy BKK immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to BKK, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with BKK, 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 BKK to are fairly valued by the market. If this does not hold true, BKK’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.