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The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Guolian Securities Co Ltd (HKG:1456) is currently trading at a trailing P/E of 12.2, which is higher than the industry average of 9.6. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 Guolian Securities
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 1456
Price-Earnings Ratio = Price per share ÷ Earnings per share
1456 Price-Earnings Ratio = CN¥1.65 ÷ CN¥0.135 = 12.2x
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 1456, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. 1456’s P/E of 12.2 is higher than its industry peers (9.6), which implies that each dollar of 1456’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Capital Markets companies in HK including Freeman FinTech, Oriental Explorer Holdings and Emperor Capital Group. You could also say that the market is suggesting that 1456 is a stronger business than the average comparable company.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to 1456. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Guolian Securities Co Ltd is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 1456 are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.