This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Tianda Pharmaceuticals Limited (HKG:455) is currently trading at a trailing P/E of 55.9, which is higher than the industry average of 15.6. Though this might seem to be a negative, 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.
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 455
Price-Earnings Ratio = Price per share ÷ Earnings per share
455 Price-Earnings Ratio = HK$0.26 ÷ HK$0.00465 = 55.9x
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 455, 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. 455’s P/E of 55.9 is higher than its industry peers (15.6), which implies that each dollar of 455’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Pharmaceuticals companies in HK including Jilin Province Huinan Changlong Bio-pharmacy, China Health Group and Livzon Pharmaceutical Group. You could also say that the market is suggesting that 455 is a stronger business than the average comparable company.
A few caveats
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to 455. If this isn’t the case, the difference in P/E could be due to other factors. For example, if Tianda Pharmaceuticals Limited is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to 455 may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
Since you may have already conducted your due diligence on 455, 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for 455’s future growth? Take a look at our free research report of analyst consensus for 455’s outlook.
- Past Track Record: Has 455 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 455’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.