OUE Hospitality Trust (SGX:SK7) is currently trading at a trailing P/E of 66.8x, which is higher than the industry average of 15.7x. While this makes SK7 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for OUE Hospitality Trust
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for SK7
Price-Earnings Ratio = Price per share ÷ Earnings per share
SK7 Price-Earnings Ratio = SGD0.89 ÷ SGD0.013 = 66.8x
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 SK7, 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. SK7’s P/E of 66.8x is higher than its industry peers (15.7x), which implies that each dollar of SK7’s earnings is being overvalued by investors. Therefore, according to this analysis, SK7 is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that SK7 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 SK7, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with SK7, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing SK7 to are fairly valued by the market. If this does not hold, there is a possibility that SK7’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in SK7. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in SK7, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.