Mansion International Holdings Limited (SEHK:8456) trades with a trailing P/E of 194x, which is higher than the industry average of 14.2x. While this makes 8456 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Mansion International Holdings

What you need to know about the P/E ratio

The P/E ratio is one of many ratios used in relative valuation. 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 8456

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

8456 Price-Earnings Ratio = HK$0.44 ÷ HK$0.002 = 194x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 8456, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. 8456’s P/E of 194x is higher than its industry peers (14.2x), which implies that each dollar of 8456’s earnings is being overvalued by investors. Therefore, according to this analysis, 8456 is an over-priced stock.

Assumptions to watch out for

However, before you rush out to sell your 8456 shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to 8456, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 8456, 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 8456 to are fairly valued by the market. If this does not hold true, 8456’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.