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Zall Group Ltd (SEHK:2098) trades with a trailing P/E of 38.5x, which is higher than the industry average of 7x. While this makes 2098 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Zall Group
Demystifying 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 2098
Price-Earnings Ratio = Price per share ÷ Earnings per share
2098 Price-Earnings Ratio = CN¥8.18 ÷ CN¥0.212 = 38.5x
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 2098, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 38.5x, 2098’s P/E is higher than its industry peers (7x). This implies that investors are overvaluing each dollar of 2098’s earnings. Therefore, according to this analysis, 2098 is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your 2098 shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to 2098. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with 2098, 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 2098 to are fairly valued by the market. If this does not hold, there is a possibility that 2098’s P/E is lower because our peer group is overvalued by the market.
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 2098. 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 highly recommend you to complete your research by taking a look at the following: