Somerley Capital Holdings Limited (SEHK:8439) is currently trading at a trailing P/E of 41.4x, which is higher than the industry average of 16.1x. While 8439 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Somerley Capital Holdings
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 8439
Price-Earnings Ratio = Price per share ÷ Earnings per share
8439 Price-Earnings Ratio = HK$1.99 ÷ HK$0.048 = 41.4x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 8439, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since 8439’s P/E of 41.4x is higher than its industry peers (16.1x), it means that investors are paying more than they should for each dollar of 8439’s earnings. As such, our analysis shows that 8439 represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your 8439 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 8439, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 8439, 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 8439 to are fairly valued by the market. If this does not hold true, 8439’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.