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HRnetGroup Limited (SGX:CHZ) is trading with a trailing P/E of 17x, which is higher than the industry average of 14.7x. While CHZ 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. Today, 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 HRnetGroup
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 CHZ
Price-Earnings Ratio = Price per share ÷ Earnings per share
CHZ Price-Earnings Ratio = SGD0.78 ÷ SGD0.046 = 17x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CHZ, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since CHZ’s P/E of 17x is higher than its industry peers (14.7x), it means that investors are paying more than they should for each dollar of CHZ’s earnings. As such, our analysis shows that CHZ represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your CHZ 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 CHZ. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with CHZ, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CHZ to are fairly valued by the market. If this does not hold, there is a possibility that CHZ’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on CHZ, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following: