In This Article:
This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
China Evergrande Group (HKG:3333) is trading with a trailing P/E of 6.1, which is higher than the industry average of 5.1. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for China Evergrande Group
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 3333
Price-Earnings Ratio = Price per share ÷ Earnings per share
3333 Price-Earnings Ratio = CN¥16.98 ÷ CN¥2.762 = 6.1x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 3333, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. 3333’s P/E of 6.1 is higher than its industry peers (5.1), which implies that each dollar of 3333’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Real Estate companies in HK including Chinney Investments, Top Spring International Holdings and Hon Kwok Land Investment Company. You could think of it like this: the market is pricing 3333 as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to 3333. If not, the difference in P/E might be a result of other factors. For example, China Evergrande Group 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 3333 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:
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 3333. 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. 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: