Kingtone Wirelessinfo Solution Holding Ltd (NASDAQ:KONE) trades with a trailing P/E of 16x, which is lower than the industry average of 33.4x. While KONE 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 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 Kingtone Wirelessinfo Solution Holding
Demystifying 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for KONE
Price per share = 3.17
Earnings per share = 0.199
∴ Price-Earnings Ratio = 3.17 ÷ 0.199 = 16x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as KONE, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
KONE’s P/E of 16x is lower than its industry peers (33.4x), which implies that each dollar of KONE’s earnings is being undervalued by investors. As such, our analysis shows that KONE represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that KONE represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to KONE. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with KONE, then investors would naturally value KONE at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with KONE, investors would also value KONE at a lower price since it is a lower growth investment. Both scenarios would explain why KONE has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing KONE to are fairly valued by the market. If this assumption does not hold true, KONE’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on KONE, 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.
Are you a potential investor? If you are considering investing in KONE, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Kingtone Wirelessinfo Solution Holding for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.