China Greenland Broad Greenstate Group Company Limited (SEHK:1253) trades with a trailing P/E of 17.7x, which is lower than the industry average of 21.7x. While 1253 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 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 China Greenland Broad Greenstate Group
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 1253
Price-Earnings Ratio = Price per share ÷ Earnings per share
1253 Price-Earnings Ratio = CN¥0.83 ÷ CN¥0.047 = 17.7x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 1253, 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. 1253’s P/E of 17.7x is lower than its industry peers (21.7x), which implies that each dollar of 1253’s earnings is being undervalued by investors. As such, our analysis shows that 1253 represents an under-priced stock.
A few caveats
However, before you rush out to buy 1253, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to 1253. 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 1253, 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 1253 to are fairly valued by the market. If this does not hold true, 1253’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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.