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COSCO Shipping International (Singapore) Co Ltd. (SGX:F83) is currently trading at a trailing P/E of 19.8x, which is higher than the industry average of 12.3x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for COSCO Shipping International (Singapore)
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 F83
Price-Earnings Ratio = Price per share ÷ Earnings per share
F83 Price-Earnings Ratio = SGD0.39 ÷ SGD0.02 = 19.8x
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 F83, 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. F83’s P/E of 19.8x is higher than its industry peers (12.3x), which implies that each dollar of F83’s earnings is being overvalued by investors. As such, our analysis shows that F83 represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that F83 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to F83, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with F83, 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 F83 to are fairly valued by the market. If this is violated, F83’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in F83. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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: