China Jishan Holdings Limited (SGX:J18) is currently trading at a trailing P/E of 7.6x, which is lower than the industry average of 20.6x. While this makes J18 appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for China Jishan Holdings
Breaking down the Price-Earnings 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 J18
Price-Earnings Ratio = Price per share ÷ Earnings per share
J18 Price-Earnings Ratio = CN¥0.57 ÷ CN¥0.075 = 7.6x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to J18, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since J18’s P/E of 7.6x is lower than its industry peers (20.6x), it means that investors are paying less than they should for each dollar of J18’s earnings. Therefore, according to this analysis, J18 is an under-priced stock.
A few caveats
However, before you rush out to buy J18, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to J18. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with J18, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing J18 to are fairly valued by the market. If this does not hold true, J18’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 add more of J18 to your portfolio. 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 urge you to complete your research by taking a look at the following: