AKM Industrial Company Limited (SEHK:1639) trades with a trailing P/E of 33.6x, which is higher than the industry average of 14.4x. 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. Today, 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 AKM Industrial
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in 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 1639
Price-Earnings Ratio = Price per share ÷ Earnings per share
1639 Price-Earnings Ratio = HK$1.9 ÷ HK$0.057 = 33.6x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 1639, 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. 1639’s P/E of 33.6x is higher than its industry peers (14.4x), which implies that each dollar of 1639’s earnings is being overvalued by investors. As such, our analysis shows that 1639 represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your 1639 shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 1639. 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 1639, 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 1639 to are fairly valued by the market. If this does not hold, there is a possibility that 1639’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.