Semiconductor Manufacturing International Corporation (SEHK:981) is currently trading at a trailing P/E of 46.3x, which is higher than the industry average of 18.6x. 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Semiconductor Manufacturing International
Breaking down the Price-Earnings 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 981
Price-Earnings Ratio = Price per share ÷ Earnings per share
981 Price-Earnings Ratio = $1.36 ÷ $0.029 = 46.3x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 981, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 46.3x, 981’s P/E is higher than its industry peers (18.6x). This implies that investors are overvaluing each dollar of 981’s earnings. As such, our analysis shows that 981 represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that 981 should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to 981. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with 981, 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 981 to are fairly valued by the market. If this does not hold true, 981’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in 981. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for 981’s future growth? Take a look at our free research report of analyst consensus for 981’s outlook.
- Past Track Record: Has 981 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 981’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 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.