SingHaiyi Group Ltd (SGX:5H0) is currently trading at a trailing P/E of 7x, which is lower than the industry average of 10.6x. While this makes 5H0 appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for SingHaiyi Group
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 5H0
Price-Earnings Ratio = Price per share ÷ Earnings per share
5H0 Price-Earnings Ratio = SGD0.12 ÷ SGD0.017 = 7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 5H0, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 7x, 5H0’s P/E is lower than its industry peers (10.6x). This implies that investors are undervaluing each dollar of 5H0’s earnings. As such, our analysis shows that 5H0 represents an under-priced stock.
A few caveats
However, before you rush out to buy 5H0, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to 5H0. 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 5H0, 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 5H0 to are fairly valued by the market. If this does not hold, there is a possibility that 5H0’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on 5H0, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above.
Are you a potential investor? If you are considering investing in 5H0, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.