In This Article:
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
MECOM Power and Construction Limited (HKG:1183) is trading with a trailing P/E of 16.3, which is higher than the industry average of 11.1. Though this might seem to be a negative, 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 MECOM Power and Construction
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in 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 1183
Price-Earnings Ratio = Price per share ÷ Earnings per share
1183 Price-Earnings Ratio = MOP1.04 ÷ MOP0.0637 = 16.3x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 1183, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 16.3, 1183’s P/E is higher than its industry peers (11.1). This implies that investors are overvaluing each dollar of 1183’s earnings. This multiple is a median of profitable companies of 25 Construction companies in HK including Grand Talents Group Holdings, PYI and HPC Holdings. You could also say that the market is suggesting that 1183 is a stronger business than the average comparable company.
Assumptions to watch out for
However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to 1183. If this isn’t the case, the difference in P/E could be due to other factors. For example, if MECOM Power and Construction Limited is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to 1183 may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to 1183. 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. 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 highly recommend you to complete your research by taking a look at the following: