Renmin Tianli Group Inc (NASDAQ:ABAC) trades with a trailing P/E of 22.6x, which is higher than the industry average of 19.7x. While this makes ABAC 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Renmin Tianli Group
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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 ABAC
Price-Earnings Ratio = Price per share ÷ Earnings per share
ABAC Price-Earnings Ratio = $2.45 ÷ $0.109 = 22.6x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ABAC, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 22.6x, ABAC’s P/E is higher than its industry peers (19.7x). This implies that investors are overvaluing each dollar of ABAC’s earnings. Therefore, according to this analysis, ABAC is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your ABAC shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to ABAC. 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 ABAC, 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 ABAC to are fairly valued by the market. If this does not hold true, ABAC’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.