HiTech Group Australia Limited (ASX:HIT) trades with a trailing P/E of 15.2x, which is lower than the industry average of 18.2x. While HIT might seem like an attractive stock to buy, 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. View our latest analysis for HiTech Group Australia
Breaking down the Price-Earnings 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 HIT
Price-Earnings Ratio = Price per share ÷ Earnings per share
HIT Price-Earnings Ratio = A$1 ÷ A$0.066 = 15.2x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to HIT, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. HIT’s P/E of 15.2x is lower than its industry peers (18.2x), which implies that each dollar of HIT’s earnings is being undervalued by investors. As such, our analysis shows that HIT represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy HIT immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to HIT. 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 HIT, 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 HIT to are fairly valued by the market. If this does not hold true, HIT’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.