Does First Tractor Company Limited’s (HKG:38) PE Ratio Signal A Selling Opportunity?
First Tractor Company Limited (SEHK:38) is currently trading at a trailing P/E of 64.2x, which is higher than the industry average of 15.3x. While this makes 38 appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 First Tractor
Demystifying the P/E ratio
P/E is a popular ratio used for 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 38
Price-Earnings Ratio = Price per share ÷ Earnings per share
38 Price-Earnings Ratio = CN¥2.91 ÷ CN¥0.045 = 64.2x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 38, 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. 38’s P/E of 64.2x is higher than its industry peers (15.3x), which implies that each dollar of 38’s earnings is being overvalued by investors. As such, our analysis shows that 38 represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that 38 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to 38, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with 38, 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 38 to are fairly valued by the market. If this does not hold true, 38’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.
