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Highway Holdings Limited (NASDAQ:HIHO) is trading with a trailing P/E of 15.9x, which is lower than the industry average of 23.8x. 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Highway Holdings
Demystifying 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 HIHO
Price-Earnings Ratio = Price per share ÷ Earnings per share
HIHO Price-Earnings Ratio = $4.3 ÷ $0.27 = 15.9x
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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to HIHO, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since HIHO’s P/E of 15.9x is lower than its industry peers (23.8x), it means that investors are paying less than they should for each dollar of HIHO’s earnings. As such, our analysis shows that HIHO represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that HIHO is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to HIHO. 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 HIHO, 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 HIHO to are fairly valued by the market. If this does not hold, there is a possibility that HIHO’s P/E is lower because our peer group is 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.