Goldin Financial Holdings Limited (SEHK:530) is trading with a trailing P/E of 19.7x, which is higher than the industry average of 13.9x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Goldin Financial Holdings
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 530
Price-Earnings Ratio = Price per share ÷ Earnings per share
530 Price-Earnings Ratio = HK$4.01 ÷ HK$0.203 = 19.7x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 530, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. 530’s P/E of 19.7x is higher than its industry peers (13.9x), which implies that each dollar of 530’s earnings is being overvalued by investors. As such, our analysis shows that 530 represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your 530 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 530, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 530, 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 530 to are fairly valued by the market. If this is violated, 530’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in 530. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in 530, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.