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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Yuzhou Properties Company Limited (HKG:1628) trades with a trailing P/E of 3.7x, which is lower than the industry average of 5.8x. While 1628 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 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 Yuzhou Properties
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 1628
Price-Earnings Ratio = Price per share ÷ Earnings per share
1628 Price-Earnings Ratio = CN¥2.96 ÷ CN¥0.790 = 3.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 1628, 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. Since 1628’s P/E of 3.7 is lower than its industry peers (5.8), it means that investors are paying less for each dollar of 1628’s earnings. This multiple is a median of profitable companies of 25 Real Estate companies in HK including Fullsun International Holdings Group, Top Spring International Holdings and Chinney Investments. One could put it like this: the market is pricing 1628 as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. The first is that our “similar companies” are actually similar to 1628, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 1628, 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 1628 to are fairly valued by the market. If this does not hold, there is a possibility that 1628’s P/E is lower because our peer group is overvalued by the market.