Hotel Grand Central Limited (SGX:H18) trades with a trailing P/E of 26.1x, which is higher than the industry average of 22.4x. While H18 might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 Hotel Grand Central

Breaking down the P/E 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 H18

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

H18 Price-Earnings Ratio = SGD1.49 ÷ SGD0.057 = 26.1x

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 H18, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since H18’s P/E of 26.1x is higher than its industry peers (22.4x), it means that investors are paying more than they should for each dollar of H18’s earnings. As such, our analysis shows that H18 represents an over-priced stock.

Assumptions to be aware of

However, before you rush out to sell your H18 shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to H18, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with H18, 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 H18 to are fairly valued by the market. If this is violated, H18’s P/E may be lower than its peers as they are actually overvalued by investors.

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.