Food Empire Holdings Limited (SGX:F03) is currently trading at a trailing P/E of 14.2x, which is higher than the industry average of 11.5x. While this makes F03 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 break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Food Empire Holdings

Breaking down the P/E ratio

P/E is often used for relative valuation since earnings power is a chief 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 F03

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

F03 Price-Earnings Ratio = $0.53 ÷ $0.037 = 14.2x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to F03, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 14.2x, F03’s P/E is higher than its industry peers (11.5x). This implies that investors are overvaluing each dollar of F03’s earnings. Therefore, according to this analysis, F03 is an over-priced stock.

A few caveats

However, before you rush out to sell your F03 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 F03. 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 F03, 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 F03 to are fairly valued by the market. If this does not hold true, F03’s lower P/E ratio may be because firms in our peer group are 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.