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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.
Country Garden Services Holdings Company Limited (HKG:6098) is currently trading at a trailing P/E of 40.8, which is higher than the industry average of 15.7. Though this might seem to be a negative, 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.
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What you need to know about 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. 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 6098
Price-Earnings Ratio = Price per share ÷ Earnings per share
6098 Price-Earnings Ratio = CN¥10.94 ÷ CN¥0.268 = 40.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 6098, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. 6098’s P/E of 40.8 is higher than its industry peers (15.7), which implies that each dollar of 6098’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Commercial Services companies in HK including REF Holdings, Beijing Enterprises Environment Group and Neway Group Holdings. You could also say that the market is suggesting that 6098 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 6098. If this isn’t the case, the difference in P/E could be due to other factors. For example, Country Garden Services Holdings Company 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. Of course, it is possible that the stocks we are comparing with 6098 are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.