Sinostar PEC Holdings Limited (SGX:C9Q) trades with a trailing P/E of 8.6x, which is lower than the industry average of 10.1x. 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. See our latest analysis for Sinostar PEC Holdings

Breaking down 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 C9Q

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

C9Q Price-Earnings Ratio = CN¥0.95 ÷ CN¥0.111 = 8.6x

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 C9Q, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since C9Q’s P/E of 8.6x is lower than its industry peers (10.1x), it means that investors are paying less than they should for each dollar of C9Q’s earnings. Therefore, according to this analysis, C9Q is an under-priced stock.

Assumptions to watch out for

However, before you rush out to buy C9Q, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to C9Q. 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 C9Q, 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 C9Q to are fairly valued by the market. If this is violated, C9Q’s P/E may be lower than its peers as they are actually overvalued 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.