In This Article:
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.
Sun Hung Kai & Co Limited (HKG:86) is currently trading at a trailing P/E of 4.6x, which is lower than the industry average of 7.3x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, 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 Sun Hung Kai
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 86
Price-Earnings Ratio = Price per share ÷ Earnings per share
86 Price-Earnings Ratio = HK$4.44 ÷ HK$0.971 = 4.6x
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 86, 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. 86’s P/E of 4.6x is lower than its industry peers (7.3x), which implies that each dollar of 86’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 16 Consumer Finance companies in HK including Zuoli Kechuang Micro-Finance, Allied Group and Allied Properties (H.K.). Therefore, according to this analysis, 86 is an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that 86 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 86, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with 86, 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 86 to are fairly valued by the market. If this is violated, 86’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on 86, 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. 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: