Bukit Sembawang Estates Limited (SGX:B61) trades with a trailing P/E of 43.6x, which is higher than the industry average of 10x. While this makes B61 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Bukit Sembawang Estates

Breaking down the Price-Earnings ratio

The P/E ratio is one of many ratios used in relative valuation. 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 B61

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

B61 Price-Earnings Ratio = SGD6.08 ÷ SGD0.139 = 43.6x

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 B61, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since B61’s P/E of 43.6x is higher than its industry peers (10x), it means that investors are paying more than they should for each dollar of B61’s earnings. Therefore, according to this analysis, B61 is an over-priced stock.

Assumptions to watch out for

However, before you rush out to sell your B61 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 B61. 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 B61, 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 B61 to are fairly valued by the market. If this is violated, B61’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.