In This Article:
Ping An Insurance (Group) Company of China Ltd (SEHK:2318) trades with a trailing P/E of 12.4x, which is lower than the industry average of 17.3x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Ping An Insurance (Group) Company of China
What you need to know about 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 2318
Price-Earnings Ratio = Price per share ÷ Earnings per share
2318 Price-Earnings Ratio = CN¥63.62 ÷ CN¥5.145 = 12.4x
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 2318, 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. 2318’s P/E of 12.4x is lower than its industry peers (17.3x), which implies that each dollar of 2318’s earnings is being undervalued by investors. Therefore, according to this analysis, 2318 is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy 2318 immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 2318. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with 2318, 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 2318 to are fairly valued by the market. If this does not hold, there is a possibility that 2318’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to 2318. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following: