Is It Time To Sell Churchill China plc (AIM:CHH) Based Off Its PE Ratio?
Churchill China plc (AIM:CHH) is trading with a trailing P/E of 21.4x, which is higher than the industry average of 12x. 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. View our latest analysis for Churchill China
Demystifying the P/E ratio
P/E is a popular ratio used for 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 pound of the company’s earnings.
P/E Calculation for CHH
Price-Earnings Ratio = Price per share ÷ Earnings per share
CHH Price-Earnings Ratio = 11.33 ÷ 0.529 = 21.4x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CHH, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. CHH’s P/E of 21.4x is higher than its industry peers (12x), which implies that each dollar of CHH’s earnings is being overvalued by investors. As such, our analysis shows that CHH represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that CHH should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to CHH, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with CHH, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing CHH to are fairly valued by the market. If this does not hold, there is a possibility that CHH’s P/E is lower because our peer group is 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 CHH. 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 CHH, 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 Churchill China 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.
