Does Luoyang Glass Company Limited’s (HKG:1108) PE Ratio Warrant A Sell?
Luoyang Glass Company Limited (SEHK:1108) trades with a trailing P/E of 129.7x, which is higher than the industry average of 15.6x. 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Luoyang Glass
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 1108
Price-Earnings Ratio = Price per share ÷ Earnings per share
1108 Price-Earnings Ratio = CN¥3.03 ÷ CN¥0.023 = 129.7x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as 1108, 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. 1108’s P/E of 129.7x is higher than its industry peers (15.6x), which implies that each dollar of 1108’s earnings is being overvalued by investors. As such, our analysis shows that 1108 represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your 1108 shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to 1108, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with 1108, 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 1108 to are fairly valued by the market. If this does not hold, there is a possibility that 1108’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
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 1108. 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. 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 1108’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 1108 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 1108’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.
