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This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
UTS Marketing Solutions Holdings Limited (HKG:6113) is trading with a trailing P/E of 37.5x, which is higher than the industry average of 16.8x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for UTS Marketing Solutions Holdings
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 6113
Price-Earnings Ratio = Price per share ÷ Earnings per share
6113 Price-Earnings Ratio = MYR0.84 ÷ MYR0.0223 = 37.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 6113, 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. Since 6113’s P/E of 37.5x is higher than its industry peers (16.8x), it means that investors are paying more than they should for each dollar of 6113’s earnings. This multiple is a median of profitable companies of 25 Commercial Services companies in HK including Country Garden Services Holdings, Neway Group Holdings and REF Holdings. As such, our analysis shows that 6113 represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that 6113 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to 6113. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with 6113, 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 6113 to are fairly valued by the market. If this does not hold, there is a possibility that 6113’s P/E is lower because our peer group is overvalued by the market.