Highway Holdings Limited (NASDAQ:HIHO) is currently trading at a trailing P/E of 22.7x, which is lower than the industry average of 27.7x. While HIHO 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. In this article, 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 Highway Holdings
What you need to know about the P/E ratio
P/E is a popular ratio used for 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 HIHO
Price-Earnings Ratio = Price per share ÷ Earnings per share
HIHO Price-Earnings Ratio = 3.45 ÷ 0.152 = 22.7x
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 HIHO, 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. Since HIHO's P/E of 22.7x is lower than its industry peers (27.7x), it means that investors are paying less than they should for each dollar of HIHO's earnings. Therefore, according to this analysis, HIHO is an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that HIHO is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to HIHO. 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 HIHO, 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 HIHO to are fairly valued by the market. If this is violated, HIHO's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on HIHO, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I've outlined above.
Are you a potential investor? If HIHO has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Highway Holdings for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.