China Green Agriculture Inc (NYSE:CGA) trades with a trailing P/E of 1.9x, which is lower than the industry average of 17.5x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for China Green Agriculture
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 CGA
Price-Earnings Ratio = Price per share ÷ Earnings per share
CGA Price-Earnings Ratio = $1.25 ÷ $0.654 = 1.9x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to CGA, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 1.9x, CGA’s P/E is lower than its industry peers (17.5x). This implies that investors are undervaluing each dollar of CGA’s earnings. As such, our analysis shows that CGA represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy CGA, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to CGA, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with CGA, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing CGA to are fairly valued by the market. If this is violated, CGA’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Since you may have already conducted your due diligence on CGA, 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. 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:
- Financial Health: Is CGA’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has CGA 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 CGA’s historicals for more clarity.
- 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 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.