Ryobi Kiso Holdings Ltd (SGX:BDN) trades with a trailing P/E of 63.5x, which is higher than the industry average of 10.5x. While this makes BDN 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. 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. View our latest analysis for Ryobi Kiso Holdings
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 BDN
Price-Earnings Ratio = Price per share ÷ Earnings per share
BDN Price-Earnings Ratio = SGD0.18 ÷ SGD0.003 = 63.5x
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 BDN, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since BDN’s P/E of 63.5x is higher than its industry peers (10.5x), it means that investors are paying more than they should for each dollar of BDN’s earnings. As such, our analysis shows that BDN represents an over-priced stock.
A few caveats
Before you jump to the conclusion that BDN should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to BDN, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with BDN, 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 BDN to are fairly valued by the market. If this does not hold true, BDN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on BDN, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above.