Huaneng Power International Inc (SEHK:902) is currently trading at a trailing P/E of 109.7x, which is higher than the industry average of 11.2x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, 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 Huaneng Power International
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 902
Price-Earnings Ratio = Price per share ÷ Earnings per share
902 Price-Earnings Ratio = CN¥3.96 ÷ CN¥0.036 = 109.7x
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 902, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. 902’s P/E of 109.7x is higher than its industry peers (11.2x), which implies that each dollar of 902’s earnings is being overvalued by investors. Therefore, according to this analysis, 902 is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your 902 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 902, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with 902, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing 902 to are fairly valued by the market. If this does not hold true, 902’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.