Nico Steel Holdings Limited (SGX:5GF) is currently trading at a trailing P/E of 28.1x, which is higher than the industry average of 18.3x. While this makes 5GF 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. 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 Nico Steel Holdings
Breaking down the Price-Earnings 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 5GF
Price-Earnings Ratio = Price per share ÷ Earnings per share
5GF Price-Earnings Ratio = $0 ÷ $0 = 28.1x
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 5GF, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since 5GF’s P/E of 28.1x is higher than its industry peers (18.3x), it means that investors are paying more than they should for each dollar of 5GF’s earnings. As such, our analysis shows that 5GF represents an over-priced stock.
A few caveats
However, before you rush out to sell your 5GF 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 5GF, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with 5GF, 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 5GF to are fairly valued by the market. If this does not hold true, 5GF’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in 5GF. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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: