Sinovac Biotech Ltd (NASDAQ:SVA) trades with a trailing P/E of 18.8x, which is lower than the industry average of 27.5x. While this makes SVA 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Sinovac Biotech
Demystifying 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 SVA
Price-Earnings Ratio = Price per share ÷ Earnings per share
SVA Price-Earnings Ratio = $8.49 ÷ $0.452 = 18.8x
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 SVA, 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 18.8x, SVA’s P/E is lower than its industry peers (27.5x). This implies that investors are undervaluing each dollar of SVA’s earnings. As such, our analysis shows that SVA represents an under-priced stock.
A few caveats
However, before you rush out to buy SVA, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to SVA. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with SVA, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing SVA to are fairly valued by the market. If this does not hold true, SVA’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 add more of SVA 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. 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 urge you to complete your research by taking a look at the following:
- Financial Health: Is SVA’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has SVA 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 SVA’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.