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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.
Trigiant Group Limited (HKG:1300) is currently trading at a trailing P/E of 5.2x, which is lower than the industry average of 9.2x. While this makes 1300 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
View our latest analysis for Trigiant Group
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 1300
Price-Earnings Ratio = Price per share ÷ Earnings per share
1300 Price-Earnings Ratio = CN¥0.94 ÷ CN¥0.179 = 5.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to 1300, 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. 1300’s P/E of 5.2 is lower than its industry peers (9.2), which implies that each dollar of 1300’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 16 Communications companies in HK including Centron Telecom International Holding, SIM Technology Group and Transtech Optelecom Science Holdings. You can think of it like this: the market is suggesting that 1300 is a weaker business than the average comparable company.
Assumptions to watch out for
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to 1300. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with 1300, 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 1300 to are fairly valued by the market. If this does not hold, there is a possibility that 1300’s P/E is lower because our peer group is overvalued by the market.