In This Article:
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.
Lap Kei Engineering (Holdings) Limited (HKG:1690) is trading with a trailing P/E of 14.1, which is higher than the industry average of 11.1. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 Lap Kei Engineering (Holdings)
Breaking down 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 1690
Price-Earnings Ratio = Price per share ÷ Earnings per share
1690 Price-Earnings Ratio = HK$0.23 ÷ HK$0.0162 = 14.1x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 1690, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. 1690’s P/E of 14.1 is higher than its industry peers (11.1), which implies that each dollar of 1690’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Construction companies in HK including PYI, HPC Holdings and Hanison Construction Holdings. You could think of it like this: the market is pricing 1690 as if it is a stronger company than the average of its industry group.
A few caveats
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to 1690. If this isn’t the case, the difference in P/E could be due to other factors. For example, Lap Kei Engineering (Holdings) 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 1690 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.