Allied Sustainability and Environmental Consultants Group Limited (SEHK:8320) is currently trading at a trailing P/E of 42.4x, which is higher than the industry average of 21.2x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Allied Sustainability and Environmental Consultants Group
Breaking down the Price-Earnings 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 8320
Price-Earnings Ratio = Price per share ÷ Earnings per share
8320 Price-Earnings Ratio = HK$0.18 ÷ HK$0.004 = 42.4x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 8320, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 42.4x, 8320’s P/E is higher than its industry peers (21.2x). This implies that investors are overvaluing each dollar of 8320’s earnings. Therefore, according to this analysis, 8320 is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that 8320 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to 8320, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with 8320, 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 8320 to are fairly valued by the market. If this is violated, 8320’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.