Should You Be Tempted To Sell China New Energy Limited (AIM:CNEL) At Its Current Price?
China New Energy Limited (AIM:CNEL) is trading with a trailing P/E of 19.5x, which is higher than the industry average of 13x. While this makes CNEL 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for China New Energy
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 pound of the company’s earnings.
P/E Calculation for CNEL
Price-Earnings Ratio = Price per share ÷ Earnings per share
CNEL Price-Earnings Ratio = 0.01 ÷ 0.006 = 19.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 CNEL, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. CNEL’s P/E of 19.5x is higher than its industry peers (13x), which implies that each dollar of CNEL’s earnings is being overvalued by investors. Therefore, according to this analysis, CNEL is an over-priced stock.
A few caveats
However, before you rush out to sell your CNEL shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CNEL. 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 CNEL, 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 CNEL to are fairly valued by the market. If this does not hold true, CNEL’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? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to CNEL. 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.
Are you a potential investor? If you are considering investing in CNEL, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 China New Energy 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.
