Vanke Property (Overseas) Limited (SEHK:1036) is currently trading at a trailing P/E of 16.2x, which is higher than the industry average of 6.6x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, 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 Vanke Property (Overseas)

Breaking down the Price-Earnings 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 1036

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

1036 Price-Earnings Ratio = HK$4.8 ÷ HK$0.297 = 16.2x

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 1036, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. 1036’s P/E of 16.2x is higher than its industry peers (6.6x), which implies that each dollar of 1036’s earnings is being overvalued by investors. Therefore, according to this analysis, 1036 is an over-priced stock.

Assumptions to be aware of

However, before you rush out to sell your 1036 shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to 1036. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with 1036, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing 1036 to are fairly valued by the market. If this does not hold true, 1036’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

What this means for you:

Are you a shareholder? 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 1036. 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.