The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Hebron Technology Co Ltd (NASDAQ:HEBT) trades with a trailing P/E of 2.8x, which is lower than the industry average of 22.7x. While HEBT 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
What you need to know about the P/E ratio
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 HEBT
Price-Earnings Ratio = Price per share ÷ Earnings per share
HEBT Price-Earnings Ratio = $1.35 ÷ $0.486 = 2.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to HEBT, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since HEBT’s P/E of 2.8 is lower than its industry peers (22.7), it means that investors are paying less for each dollar of HEBT’s earnings. This multiple is a median of profitable companies of 24 Machinery companies in US including EnPro Industries, China Yuchai International and Meritor. You can think of it like this: the market is suggesting that HEBT is a weaker business than the average comparable company.
Assumptions to watch out for
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to HEBT, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with HEBT, 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 HEBT to are fairly valued by the market. If this does not hold, there is a possibility that HEBT’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 HEBT, 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for HEBT’s future growth? Take a look at our free research report of analyst consensus for HEBT’s outlook.
- Past Track Record: Has HEBT 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 HEBT’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.