C&D International Investment Group Limited (SEHK:1908) trades with a trailing P/E of 174.7x, which is higher than the industry average of 9.1x. While this makes 1908 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. 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. View our latest analysis for C&D International Investment Group
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 1908
Price-Earnings Ratio = Price per share ÷ Earnings per share
1908 Price-Earnings Ratio = CN¥6.16 ÷ CN¥0.035 = 174.7x
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 1908, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since 1908’s P/E of 174.7x is higher than its industry peers (9.1x), it means that investors are paying more than they should for each dollar of 1908’s earnings. Therefore, according to this analysis, 1908 is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your 1908 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 1908. 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 1908, 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 1908 to are fairly valued by the market. If this does not hold, there is a possibility that 1908’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.