Yoma Strategic Holdings Ltd (SGX:Z59) is currently trading at a trailing P/E of 14.8x, which is higher than the industry average of 9.9x. While Z59 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Yoma Strategic Holdings

Breaking down the P/E ratio

P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 Z59

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

Z59 Price-Earnings Ratio = SGD0.41 ÷ SGD0.027 = 14.8x

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 Z59, 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. Z59’s P/E of 14.8x is higher than its industry peers (9.9x), which implies that each dollar of Z59’s earnings is being overvalued by investors. Therefore, according to this analysis, Z59 is an over-priced stock.

A few caveats

Before you jump to the conclusion that Z59 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to Z59. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with Z59, 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 Z59 to are fairly valued by the market. If this is violated, Z59’s P/E may be lower than its peers as they are actually overvalued by investors.

What this means for you:

Since you may have already conducted your due diligence on Z59, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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:

1. Future Outlook: What are well-informed industry analysts predicting for Z59’s future growth? Take a look at our free research report of analyst consensus for Z59’s outlook.

2. Past Track Record: Has Z59 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 Z59’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.