I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Beijing North Star Company Limited (HKG:588) trades on a trailing P/E of 6.2. This isn’t too far from the industry average (which is 6.3). While 588 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 588
Price-Earnings Ratio = Price per share ÷ Earnings per share
588 Price-Earnings Ratio = CN¥2.12 ÷ CN¥0.344 = 6.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 588, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Beijing North Star Company Limited (HKG:588) trades on a trailing P/E of 6.2. This isn’t too far from the industry average (which is 6.3). This multiple is a median of profitable companies of 25 Real Estate companies in HK including Fullsun International Holdings Group, Redsun Properties Group and Top Spring International Holdings. One could put it like this: the market is pricing 588 as if it is roughly average for its industry.
A few caveats
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to 588. 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 588, 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 588 to are fairly valued by the market. If this is violated, 588’s P/E may be lower than its peers as they are actually overvalued by investors.
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 588. 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 588’s future growth? Take a look at our free research report of analyst consensus for 588’s outlook.
- Past Track Record: Has 588 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 588’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 past 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. For errors that warrant correction please contact the editor at email@example.com.