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This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Paladin Limited (HKG:495) trades with a trailing P/E of 17.6, which is higher than the industry average of 5.7. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
View our latest analysis for Paladin
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 495
Price-Earnings Ratio = Price per share ÷ Earnings per share
495 Price-Earnings Ratio = HK$0.21 ÷ HK$0.0117 = 17.6x
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 495, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since 495’s P/E of 17.6 is higher than its industry peers (5.7), it means that investors are paying more for each dollar of 495’s earnings. This multiple is a median of profitable companies of 25 Real Estate companies in HK including Top Spring International Holdings, Chinney Investments and Hon Kwok Land Investment Company. You could also say that the market is suggesting that 495 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 495. If this isn’t the case, the difference in P/E could be due to other factors. For example, Paladin Limited could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to 495 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.