Hupsteel Limited (SGX:BMH) trades with a trailing P/E of 37x, which is higher than the industry average of 20.4x. While this makes BMH 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Hupsteel

Breaking down the P/E ratio

P/E is a popular ratio used for 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 BMH

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

BMH Price-Earnings Ratio = SGD0.91 ÷ SGD0.024 = 37x

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 BMH, 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. Since BMH’s P/E of 37x is higher than its industry peers (20.4x), it means that investors are paying more than they should for each dollar of BMH’s earnings. Therefore, according to this analysis, BMH is an over-priced stock.

A few caveats

However, before you rush out to sell your BMH shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to BMH. 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 BMH, 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 BMH to are fairly valued by the market. If this does not hold true, BMH’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

What this means for you:

Since you may have already conducted your due diligence on BMH, 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. 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:

1. Financial Health: Is BMH’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.

2. Past Track Record: Has BMH been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of BMH’s historicals for more clarity.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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.