Should You Be Tempted To Sell China Recycling Energy Corporation (CREG) At Its Current Price?
China Recycling Energy Corporation (NASDAQ:CREG) is currently trading at a trailing P/E of 73.4x, which is higher than the industry average of 26.1x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, 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. Check out our latest analysis for China Recycling Energy
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for CREG
Price-Earnings Ratio = Price per share ÷ Earnings per share
CREG Price-Earnings Ratio = 1.15 ÷ 0.016 = 73.4x
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 CREG, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since CREG's P/E of 73.4x is higher than its industry peers (26.1x), it means that investors are paying more than they should for each dollar of CREG's earnings. As such, our analysis shows that CREG represents an over-priced stock.
A few caveats
Before you jump to the conclusion that CREG should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to CREG. 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 CREG, 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 CREG to are fairly valued by the market. If this does not hold true, CREG’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? Since you may have already conducted your due diligence on CREG, 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.
Are you a potential investor? If CREG 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 China Recycling 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.
