This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

Progressive Path Group Holdings Limited (HKG:1581) is trading with a trailing P/E of 46.3, which is higher than the industry average of 9.4. While this might not seem positive, 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 Progressive Path Group Holdings

Breaking down the P/E 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 1581

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

1581 Price-Earnings Ratio = HK$0.26 ÷ HK$0.00550 = 46.3x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 1581, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. 1581’s P/E of 46.3 is higher than its industry peers (9.4), which implies that each dollar of 1581’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Trade Distributors companies in HK including China Strategic Holdings, North Asia Strategic Holdings and Samson Paper Holdings. You could also say that the market is suggesting that 1581 is a stronger business than the average comparable company.

Assumptions to watch out for

Before you jump to conclusions it is important to realise that there are assumptions in this analysis. Firstly, that our peer group contains companies that are similar to 1581. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Progressive Path Group Holdings Limited is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 1581 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.