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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Gemini Investments (Holdings) Limited (HKG:174) is currently trading at a trailing P/E of 19, which is higher than the industry average of 9.6. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. 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 Gemini Investments (Holdings)
Breaking down the Price-Earnings 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 174
Price-Earnings Ratio = Price per share ÷ Earnings per share
174 Price-Earnings Ratio = HK$0.89 ÷ HK$0.0467 = 19x
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 174, 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 19, 174’s P/E is higher than its industry peers (9.6). This implies that investors are overvaluing each dollar of 174’s earnings. This multiple is a median of profitable companies of 25 Capital Markets companies in HK including Freeman FinTech, Oriental Explorer Holdings and Emperor Capital Group. You could also say that the market is suggesting that 174 is a stronger business than the average comparable company.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to 174. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where Gemini Investments (Holdings) Limited is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 174 are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.