Kaisun Energy Group Limited (SEHK:8203) is trading with a trailing P/E of 3.1x, which is lower than the industry average of 11.7x. While this makes 8203 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Kaisun Energy Group
What you need to know about 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. 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 8203
Price-Earnings Ratio = Price per share ÷ Earnings per share
8203 Price-Earnings Ratio = HK$0.28 ÷ HK$0.091 = 3.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 8203, 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. At 3.1x, 8203’s P/E is lower than its industry peers (11.7x). This implies that investors are undervaluing each dollar of 8203’s earnings. As such, our analysis shows that 8203 represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy 8203, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to 8203, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 8203, 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 8203 to are fairly valued by the market. If this is violated, 8203’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? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to 8203. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in 8203, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.