Should You Be Tempted To Sell China Distance Education Holdings Limited (NYSE:DL) At Its Current PE Ratio?
China Distance Education Holdings Limited (NYSE:DL) is currently trading at a trailing P/E of 45.2x, which is higher than the industry average of 25.7x. While this makes DL appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for China Distance Education Holdings
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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 DL
Price-Earnings Ratio = Price per share ÷ Earnings per share
DL Price-Earnings Ratio = $7.66 ÷ $0.169 = 45.2x
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 DL, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 45.2x, DL’s P/E is higher than its industry peers (25.7x). This implies that investors are overvaluing each dollar of DL’s earnings. As such, our analysis shows that DL represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your DL shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to DL, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with DL, 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 DL to are fairly valued by the market. If this does not hold, there is a possibility that DL’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on DL, the overvaluation of the stock may mean it is a good time to reduce 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. 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:
Financial Health: Is DL’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
Past Track Record: Has DL 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 DL’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.
