The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Sing Investments & Finance Limited (SGX:S35) is currently trading at a trailing P/E of 10.6x, which is lower than the industry average of 19.2x. While S35 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
See our latest analysis for Sing Investments & Finance
Breaking down the Price-Earnings 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 S35
Price-Earnings Ratio = Price per share ÷ Earnings per share
S35 Price-Earnings Ratio = SGD1.56 ÷ SGD0.148 = 10.6x
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 S35, 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. S35’s P/E of 10.6x is lower than its industry peers (15.6x), which implies that each dollar of S35’s earnings is being undervalued by investors. Since the Consumer Finance sector in SG is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as ValueMax Group, Hong Leong Finance and Singapura Finance. As such, our analysis shows that S35 represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy S35, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to S35, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with S35, 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 S35 to are fairly valued by the market. If this does not hold, there is a possibility that S35’s P/E is lower because our peer group is overvalued by the market.