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.
Hing Lee (HK) Holdings Limited (HKG:396) is trading with a trailing P/E of 45.7x, which is higher than the industry average of 13.1x. While 396 might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for Hing Lee (HK) Holdings
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in 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 396
Price-Earnings Ratio = Price per share ÷ Earnings per share
396 Price-Earnings Ratio = HK$0.41 ÷ HK$0.00898 = 45.7x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 396, 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 396’s P/E of 45.7x is higher than its industry peers (13.1x), it means that investors are paying more than they should for each dollar of 396’s earnings. This multiple is a median of profitable companies of 25 Consumer Durables companies in HK including Miji International Holdings, Samson Holding and China Baofeng (International). Therefore, according to this analysis, 396 is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your 396 shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to 396, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 396, 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 396 to are fairly valued by the market. If this is violated, 396’s P/E may be lower than its peers as they are actually overvalued by investors.