In This Article:
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.
Shandong Weigao Group Medical Polymer Company Limited (HKG:1066) is currently trading at a trailing P/E of 23.9, which is higher than the industry average of 21.2. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for Shandong Weigao Group Medical Polymer
Demystifying 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 1066
Price-Earnings Ratio = Price per share ÷ Earnings per share
1066 Price-Earnings Ratio = CN¥6.72 ÷ CN¥0.281 = 23.9x
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 1066, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 23.9, 1066’s P/E is higher than its industry peers (21.2). This implies that investors are overvaluing each dollar of 1066’s earnings. This multiple is a median of profitable companies of 11 Medical Equipment companies in HK including Beijing Enterprises Medical and Health Industry Group, Modern Dental Group and China Isotope & Radiation. You could think of it like this: the market is pricing 1066 as if it is a stronger company than the average of its industry group.
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 1066. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Shandong Weigao Group Medical Polymer Company Limited 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 1066 are not 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.