Kingtone Wirelessinfo Solution Holding Ltd (NASDAQ:KONE) trades with a trailing P/E of 16.9x, which is lower than the industry average of 42.3x. While this makes KONE appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for KONE
Demystifying 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 KONE
Price-Earnings Ratio = Price per share ÷ Earnings per share
KONE Price-Earnings Ratio = 3.35 ÷ 0.199 = 16.9x
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 KONE, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. KONE’s P/E of 16.9x is lower than its industry peers (42.3x), which implies that each dollar of KONE’s earnings is being undervalued by investors. As such, our analysis shows that KONE represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy KONE, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to KONE, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with KONE, 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 KONE to are fairly valued by the market. If this does not hold true, KONE’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of KONE to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in KONE, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Kingtone Wirelessinfo Solution Holding for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.