Jupai Holdings Limited (NYSE:JP) is currently trading at a trailing P/E of 9.6x, which is lower than the industry average of 16.5x. While this makes JP 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 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 Jupai Holdings
Breaking down 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 JP
Price-Earnings Ratio = Price per share ÷ Earnings per share
JP Price-Earnings Ratio = CN¥112.42 ÷ CN¥11.767 = 9.6x
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 JP, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since JP’s P/E of 9.6x is lower than its industry peers (16.5x), it means that investors are paying less than they should for each dollar of JP’s earnings. Therefore, according to this analysis, JP is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy JP immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to JP, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with JP, 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 JP to are fairly valued by the market. If this does not hold true, JP’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? 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 JP 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.
Are you a potential investor? If you are considering investing in JP, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 Jupai 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.