In This Article:
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.
UMP Healthcare Holdings Limited (HKG:722) is trading with a trailing P/E of 34.5, which is higher than the industry average of 28.6. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
See our latest analysis for UMP Healthcare Holdings
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. 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 722
Price-Earnings Ratio = Price per share ÷ Earnings per share
722 Price-Earnings Ratio = HK$1.74 ÷ HK$0.0504 = 34.5x
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 722, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 34.5, 722’s P/E is higher than its industry peers (28.6). This implies that investors are overvaluing each dollar of 722’s earnings. This multiple is a median of profitable companies of 20 Healthcare companies in HK including Genertec Universal Medical Group, China Pioneer Pharma Holdings and China NT Pharma Group. You could think of it like this: the market is pricing 722 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 722. If not, the difference in P/E might be a result of other factors. For example, UMP Healthcare Holdings Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to 722 may not be 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:
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 722. 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 highly recommend you to complete your research by taking a look at the following: