This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Theme International Holdings Limited (HKG:990) is currently trading at a trailing P/E of 40, which is higher than the industry average of 9.4. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. Today, 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 Theme International Holdings
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 990
Price-Earnings Ratio = Price per share ÷ Earnings per share
990 Price-Earnings Ratio = HK$0.16 ÷ HK$0.00410 = 40x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 990, 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 40, 990’s P/E is higher than its industry peers (9.4). This implies that investors are overvaluing each dollar of 990’s earnings. This multiple is a median of profitable companies of 24 Trade Distributors companies in HK including APAC Resources, China Strategic Holdings and North Asia Strategic Holdings. You could think of it like this: the market is pricing 990 as if it is a stronger company than the average of its industry group.
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 990. If not, the difference in P/E might be a result of other factors. For example, if Theme International 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 990 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 990. 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: