Samudera Shipping Line Ltd (SGX:S56) is trading with a trailing P/E of 15.4x, which is higher than the industry average of 14.2x. While this makes S56 appear like a stock to avoid or sell if you own it, 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. See our latest analysis for Samudera Shipping Line

Breaking down the Price-Earnings 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 S56

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

S56 Price-Earnings Ratio = $0.17 ÷ $0.011 = 15.4x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to S56, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 15.4x, S56’s P/E is higher than its industry peers (14.2x). This implies that investors are overvaluing each dollar of S56’s earnings. As such, our analysis shows that S56 represents an over-priced stock.

Assumptions to watch out for

However, before you rush out to sell your S56 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 S56, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with S56, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing S56 to are fairly valued by the market. If this does not hold, there is a possibility that S56’s P/E is lower because our peer group is overvalued by the market.

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 S56. 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:

1. Financial Health: Is S56’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.

2. Past Track Record: Has S56 been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of S56’s historicals for more clarity.

3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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.