Tai Kam Holdings Limited (SEHK:8321) is currently trading at a trailing P/E of 24.3x, which is higher than the industry average of 9.5x. 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. 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 Tai Kam Holdings
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 8321
Price-Earnings Ratio = Price per share ÷ Earnings per share
8321 Price-Earnings Ratio = HK$0.21 ÷ HK$0.009 = 24.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 8321, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 24.3x, 8321’s P/E is higher than its industry peers (9.5x). This implies that investors are overvaluing each dollar of 8321’s earnings. Therefore, according to this analysis, 8321 is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your 8321 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 8321. 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 8321, 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 8321 to are fairly valued by the market. If this does not hold true, 8321’s lower P/E ratio may be because firms in our peer group are 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.