Tian Ge Interactive Holdings Limited (SEHK:1980) is trading with a trailing P/E of 22.6x, which is lower than the industry average of 28.7x. While 1980 might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Tian Ge Interactive Holdings
What you need to know about 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 1980
Price-Earnings Ratio = Price per share ÷ Earnings per share
1980 Price-Earnings Ratio = CN¥5.68 ÷ CN¥0.251 = 22.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 1980, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 22.6x, 1980’s P/E is lower than its industry peers (28.7x). This implies that investors are undervaluing each dollar of 1980’s earnings. As such, our analysis shows that 1980 represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy 1980, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to 1980, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 1980, 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 1980 to are fairly valued by the market. If this is violated, 1980’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of 1980 to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in 1980, 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.