Oxley Holdings Limited (SGX:5UX) trades with a trailing P/E of 8.2x, which is lower than the industry average of 10.6x. While this makes 5UX appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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. See our latest analysis for Oxley Holdings

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 5UX

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

5UX Price-Earnings Ratio = SGD0.67 ÷ SGD0.081 = 8.2x

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 5UX, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since 5UX’s P/E of 8.2x is lower than its industry peers (10.6x), it means that investors are paying less than they should for each dollar of 5UX’s earnings. As such, our analysis shows that 5UX represents an under-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that 5UX is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to 5UX. 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 5UX, 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 5UX to are fairly valued by the market. If this does not hold true, 5UX’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

What this means for you:

Are you a shareholder? Since you may have already conducted your due diligence on 5UX, the undervaluation of the stock may mean it is a good time to top up on 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.

Are you a potential investor? If you are considering investing in 5UX, 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.