In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
China Railway Signal & Communication Corporation Limited (HKG:3969) is trading with a trailing P/E of 12.2, which is higher than the industry average of 9.5. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
See our latest analysis for China Railway Signal & Communication
Breaking down the P/E ratio
P/E is a popular ratio used for 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 3969
Price-Earnings Ratio = Price per share ÷ Earnings per share
3969 Price-Earnings Ratio = CN¥4.85 ÷ CN¥0.398 = 12.2x
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 3969, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 12.2, 3969’s P/E is higher than its industry peers (9.5). This implies that investors are overvaluing each dollar of 3969’s earnings. This multiple is a median of profitable companies of 25 Electronic companies in HK including China Soft Power Technology Holdings, Wong’s International Holdings and AV Concept Holdings. You could also say that the market is suggesting that 3969 is a stronger business than the average comparable company.
Assumptions to be aware of
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to 3969. If this isn’t the case, the difference in P/E could be due to other factors. For example, China Railway Signal & Communication Corporation Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to 3969 may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.