This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.

Huajin International Holdings Limited (HKG:2738) is currently trading at a trailing P/E of 28.7, which is higher than the industry average of 8.6. While this might not seem positive, 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 Huajin International Holdings

Demystifying the P/E ratio

P/E is a popular ratio used for relative valuation. 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 2738

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

2738 Price-Earnings Ratio = CN¥2.49 ÷ CN¥0.0868 = 28.7x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 2738, 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. 2738’s P/E of 28.7 is higher than its industry peers (8.6), which implies that each dollar of 2738’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Metals and Mining companies in HK including Hong Kong Finance Investment Holding Group, IRC and E-Commodities Holdings. You could also say that the market is suggesting that 2738 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. The first is that our “similar companies” are actually similar to 2738. If not, the difference in P/E might be a result of other factors. For example, Huajin International Holdings 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 2738 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.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to 2738. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 urge you to complete your research by taking a look at the following: