I am writing today to help inform people who are new to the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Procurri Corporation Limited (SGX:BVQ) is currently trading at a trailing P/E of 76.2x, which is higher than the industry average of 10.1x. While BVQ might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Check out our latest analysis for Procurri
What you need to know about 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 BVQ
Price-Earnings Ratio = Price per share ÷ Earnings per share
BVQ Price-Earnings Ratio = SGD0.27 ÷ SGD0.00354 = 76.2x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to BVQ, 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 76.2x, BVQ’s P/E is higher than its industry peers (10.1x). This implies that investors are overvaluing each dollar of BVQ’s earnings. This multiple is a median of profitable companies of 18 Electronic companies in SG including Willas-Array Electronics (Holdings), Ban Leong Technologies and mDR. As such, our analysis shows that BVQ represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your BVQ shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to BVQ. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with BVQ, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing BVQ to are fairly valued by the market. If this does not hold true, BVQ’s lower P/E ratio may be because firms in our peer group are overvalued by the market.