I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Henderson Land Development Company Limited (HKG:12) is trading with a trailing P/E of 5.1, which is close to the industry average of 5.2. While 12 might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
View our latest analysis for Henderson Land Development
Demystifying 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 12
Price-Earnings Ratio = Price per share ÷ Earnings per share
12 Price-Earnings Ratio = HK$37.7 ÷ HK$7.36 = 5.1x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 12, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Henderson Land Development Company Limited (HKG:12) is trading with a trailing P/E of 5.1, which is close to the industry average of 5.2. This multiple is a median of profitable companies of 25 Real Estate companies in HK including Chinney Investments, Top Spring International Holdings and Hon Kwok Land Investment Company. One could put it like this: the market is pricing 12 as if it is roughly average for its industry.
Assumptions to be aware of
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 12. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with 12, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing 12 to are fairly valued by the market. If this is violated, 12’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 add more of 12 to your portfolio. 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 urge you to complete your research by taking a look at the following: