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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.
Beijing Jingkelong Company Limited (HKG:814) is currently trading at a trailing P/E of 11.6x, which is lower than the industry average of 14.3x. While 814 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
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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 814
Price-Earnings Ratio = Price per share ÷ Earnings per share
814 Price-Earnings Ratio = CN¥1.41 ÷ CN¥0.121 = 11.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 814, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. 814’s P/E of 11.6 is lower than its industry peers (14.3), which implies that each dollar of 814’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 18 Consumer Retailing companies in HK including Hong Kong Food Investment Holdings, China Fortune Investments (Holding) and C.P. Lotus. One could put it like this: the market is pricing 814 as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to 814. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with 814, 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 814 to are fairly valued by the market. If this does not hold true, 814’s lower P/E ratio may be because firms in our peer group are overvalued by the market.