SORL Auto Parts Inc (NASDAQ:SORL) is currently trading at a trailing P/E of 3.8x, which is lower than the industry average of 15x. While SORL might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for SORL Auto Parts
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 SORL
Price-Earnings Ratio = Price per share ÷ Earnings per share
SORL Price-Earnings Ratio = $5.07 ÷ $1.33 = 3.8x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SORL, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. SORL’s P/E of 3.8x is lower than its industry peers (15x), which implies that each dollar of SORL’s earnings is being undervalued by investors. Therefore, according to this analysis, SORL is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy SORL immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SORL. 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 SORL, 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 SORL to are fairly valued by the market. If this does not hold, there is a possibility that SORL’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to SORL. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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:
- Future Outlook: What are well-informed industry analysts predicting for SORL’s future growth? Take a look at our free research report of analyst consensus for SORL’s outlook.
- Past Track Record: Has SORL 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 SORL’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.