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AAC Technologies Holdings Inc (SEHK:2018) is currently trading at a trailing P/E of 30.1x, which is higher than the industry average of 14.3x. 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. 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 AAC Technologies Holdings
What you need to know about the P/E 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 2018
Price-Earnings Ratio = Price per share ÷ Earnings per share
2018 Price-Earnings Ratio = CN¥124.1 ÷ CN¥4.128 = 30.1x
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 2018, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since 2018’s P/E of 30.1x is higher than its industry peers (14.3x), it means that investors are paying more than they should for each dollar of 2018’s earnings. Therefore, according to this analysis, 2018 is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your 2018 shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 2018. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with 2018, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing 2018 to are fairly valued by the market. If this does not hold, there is a possibility that 2018’s P/E is lower because our peer group is 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.