This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Xinyuan Real Estate Co Ltd (NYSE:XIN) trades with a trailing P/E of 5.2x, which is lower than the industry average of 8.5x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down 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 XIN
Price-Earnings Ratio = Price per share ÷ Earnings per share
XIN Price-Earnings Ratio = $3.68 ÷ $0.709 = 5.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to XIN, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. XIN’s P/E of 5.2x is lower than its industry peers (8.5x), which implies that each dollar of XIN’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 25 Real Estate companies in US including Sunrise Real Estate Group, Guangzhou R&F Properties and Guangzhou R&F Properties. Therefore, according to this analysis, XIN is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy XIN immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to XIN. 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 XIN, 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 XIN to are fairly valued by the market. If this does not hold, there is a possibility that XIN’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 XIN. 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 XIN’s future growth? Take a look at our free research report of analyst consensus for XIN’s outlook.
- Past Track Record: Has XIN 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 XIN’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.