This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
Want Want China Holdings Limited (HKG:151) trades with a trailing P/E of 22.1x, which is higher than the industry average of 13.1x. While this makes 151 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Want Want China Holdings
What you need to know about the P/E 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 151
Price-Earnings Ratio = Price per share ÷ Earnings per share
151 Price-Earnings Ratio = CN¥5.45 ÷ CN¥0.247 = 22.1x
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. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 151, 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 22.1x, 151’s P/E is higher than its industry peers (13.1x). This implies that investors are overvaluing each dollar of 151’s earnings. This multiple is a median of profitable companies of 25 Food companies in HK including China Haisheng Juice Holdings, China Starch Holdings and Chia Tai Enterprises International. Therefore, according to this analysis, 151 is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your 151 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 151. 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 151, 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 151 to are fairly valued by the market. If this is violated, 151’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in 151. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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: