Sing Investments & Finance Limited (SGX:S35) is currently trading at a trailing P/E of 11.5x, which is lower than the industry average of 18.7x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. 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 Sing Investments & Finance

Breaking down the Price-Earnings ratio

A common ratio used for relative valuation is the P/E ratio. 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 S35

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

S35 Price-Earnings Ratio = SGD1.53 ÷ SGD0.133 = 11.5x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to S35, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 11.5x, S35’s P/E is lower than its industry peers (18.7x). This implies that investors are undervaluing each dollar of S35’s earnings. As such, our analysis shows that S35 represents an under-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to buy S35 immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to S35. 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 S35, 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 S35 to are fairly valued by the market. If this does not hold true, S35’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.