This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Sa Sa International Holdings Limited (HKG:178) is currently trading at a trailing P/E of 26.5, which is higher than the industry average of 10.7. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
See our latest analysis for Sa Sa International Holdings
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 178
Price-Earnings Ratio = Price per share ÷ Earnings per share
178 Price-Earnings Ratio = HK$4.1 ÷ HK$0.155 = 26.5x
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 178, 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. Since 178’s P/E of 26.5 is higher than its industry peers (10.7), it means that investors are paying more for each dollar of 178’s earnings. This multiple is a median of profitable companies of 25 Specialty Retail companies in HK including Sunfonda Group Holdings, Beijing Digital Telecom and China Harmony New Energy Auto Holding. You could also say that the market is suggesting that 178 is a stronger business than the average comparable company.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to 178. If not, the difference in P/E might be a result of other factors. For example, if Sa Sa International Holdings Limited is growing faster than its peers, then it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with 178 are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to 178. 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. 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: