Huan Hsin Holdings Ltd (SGX:H16) is trading with a trailing P/E of 0.3x, which is lower than the industry average of 10.6x. While this makes H16 appear like a great stock to buy, 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. Check out our latest analysis for Huan Hsin Holdings
Demystifying the P/E ratio
P/E is a popular ratio used for 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 H16
Price-Earnings Ratio = Price per share ÷ Earnings per share
H16 Price-Earnings Ratio = SGD0.02 ÷ SGD0.059 = 0.3x
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 H16, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. H16’s P/E of 0.3x is lower than its industry peers (10.6x), which implies that each dollar of H16’s earnings is being undervalued by investors. As such, our analysis shows that H16 represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that H16 is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to H16, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with H16, 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 H16 to are fairly valued by the market. If this is violated, H16’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to H16. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in H16, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.