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Is China Grand Pharmaceutical and Healthcare Holdings Limited (HKG:512) Attractive At This PE Ratio?

This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

China Grand Pharmaceutical and Healthcare Holdings Limited (HKG:512) is trading with a trailing P/E of 19.7, which is higher than the industry average of 15.6. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.

View our latest analysis for China Grand Pharmaceutical and Healthcare Holdings

Breaking down the Price-Earnings ratio

SEHK:512 PE PEG Gauge September 11th 18
SEHK:512 PE PEG Gauge September 11th 18

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 512

Price-Earnings Ratio = Price per share ÷ Earnings per share

512 Price-Earnings Ratio = HK$4.95 ÷ HK$0.252 = 19.7x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 512, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 19.7, 512’s P/E is higher than its industry peers (15.6). This implies that investors are overvaluing each dollar of 512’s earnings. This multiple is a median of profitable companies of 24 Pharmaceuticals companies in HK including Jilin Province Huinan Changlong Bio-pharmacy, China Health Group and Shandong Xinhua Pharmaceutical. You could think of it like this: the market is pricing 512 as if it is a stronger company than the average of its industry group.

Assumptions to watch out for

Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to 512. If not, the difference in P/E might be a result of other factors. For example, if China Grand Pharmaceutical and Healthcare 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 512 are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.

What this means for you:

If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in 512. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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:

  1. Future Outlook: What are well-informed industry analysts predicting for 512’s future growth? Take a look at our free research report of analyst consensus for 512’s outlook.

  2. Past Track Record: Has 512 been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of 512’s historicals for more clarity.

  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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