I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
China Telecom Corporation Limited (HKG:728) trades on a trailing P/E of 13.8. This isn’t too far from the industry average (which is 13.8). While 728 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. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
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 728
Price-Earnings Ratio = Price per share ÷ Earnings per share
728 Price-Earnings Ratio = CN¥3.34 ÷ CN¥0.243 = 13.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 728, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. China Telecom Corporation Limited (HKG:728) is currently trading at a trailing P/E of 13.8, which is close to the industry average of 13.8. This multiple is a median of profitable companies of 10 Telecom companies in HK including Great Wall Belt & Road Holdings, APT Satellite Holdings and Asia Satellite Telecommunications Holdings. You can think of it like this: the market is suggesting that 728 has similar prospects to its peers in the same industry.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to 728. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with 728, 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 728 to are fairly valued by the market. If this does not hold, there is a possibility that 728’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on 728, 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:
- Future Outlook: What are well-informed industry analysts predicting for 728’s future growth? Take a look at our free research report of analyst consensus for 728’s outlook.
- Past Track Record: Has 728 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 728’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 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 firstname.lastname@example.org.