Sunningdale Tech Ltd (SGX:BHQ) is trading with a trailing P/E of 11.9x, which is higher than the industry average of 10.2x. While this makes BHQ 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. 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 Sunningdale Tech

What you need to know about the P/E ratio

The P/E ratio is one of many ratios used in 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 BHQ

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

BHQ Price-Earnings Ratio = SGD1.98 ÷ SGD0.167 = 11.9x

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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to BHQ, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. BHQ’s P/E of 11.9x is higher than its industry peers (10.2x), which implies that each dollar of BHQ’s earnings is being overvalued by investors. Therefore, according to this analysis, BHQ is an over-priced stock.

A few caveats

While our conclusion might prompt you to sell your BHQ shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to BHQ, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with BHQ, 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 BHQ to are fairly valued by the market. If this does not hold, there is a possibility that BHQ’s P/E is lower because our peer group is overvalued by the market.

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.