BRC Asia Limited (SGX:BEC) is currently trading at a trailing P/E of 92.3x, which is higher than the industry average of 22.3x. While this makes BEC appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, 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 BRC Asia

Breaking down the P/E ratio

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 BEC

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

BEC Price-Earnings Ratio = SGD1.39 ÷ SGD0.015 = 92.3x

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 BEC, 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. BEC’s P/E of 92.3x is higher than its industry peers (22.3x), which implies that each dollar of BEC’s earnings is being overvalued by investors. Therefore, according to this analysis, BEC is an over-priced stock.

Assumptions to watch out for

However, before you rush out to sell your BEC shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to BEC. 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 BEC, 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 BEC to are fairly valued by the market. If this does not hold, there is a possibility that BEC’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.