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Singapura Finance Ltd (SGX:S23) is trading with a trailing P/E of 23.3x, which is higher than the industry average of 19x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. 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. Check out our latest analysis for Singapura Finance
What you need to know about 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 S23
Price-Earnings Ratio = Price per share ÷ Earnings per share
S23 Price-Earnings Ratio = SGD1.04 ÷ SGD0.045 = 23.3x
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 S23, 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. At 23.3x, S23’s P/E is higher than its industry peers (19x). This implies that investors are overvaluing each dollar of S23’s earnings. As such, our analysis shows that S23 represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your S23 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 S23. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with S23, 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 S23 to are fairly valued by the market. If this is violated, S23’s P/E may be lower than its peers as they are actually overpriced by investors.
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.