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Techtronic Industries Company Limited (SEHK:669) trades with a trailing P/E of 25.7x, which is higher than the industry average of 15.6x. While this makes 669 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. 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 Techtronic Industries
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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 669
Price-Earnings Ratio = Price per share ÷ Earnings per share
669 Price-Earnings Ratio = $6.11 ÷ $0.238 = 25.7x
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 669, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 25.7x, 669’s P/E is higher than its industry peers (15.6x). This implies that investors are overvaluing each dollar of 669’s earnings. Therefore, according to this analysis, 669 is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your 669 shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 669. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with 669, 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 669 to are fairly valued by the market. If this does not hold, there is a possibility that 669’s P/E is lower because our peer group is 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.