Yahoo Finance Does China Lodging Group Limited’s (NASDAQ:HTHT) PE Ratio Warrant A Sell?
China Lodging Group Limited (NASDAQ:HTHT) is trading with a trailing P/E of 63.6x, which is higher than the industry average of 23x. While this makes HTHT 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for China Lodging Group
What you need to know about 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 HTHT
Price-Earnings Ratio = Price per share ÷ Earnings per share
HTHT Price-Earnings Ratio = CN¥1102.63 ÷ CN¥17.341 = 63.6x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to HTHT, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since HTHT’s P/E of 63.6x is higher than its industry peers (23x), it means that investors are paying more than they should for each dollar of HTHT’s earnings. As such, our analysis shows that HTHT represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that HTHT 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 HTHT, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with HTHT, 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 HTHT to are fairly valued by the market. If this does not hold true, HTHT’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in HTHT. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for HTHT’s future growth? Take a look at our free research report of analyst consensus for HTHT’s outlook.
Past Track Record: Has HTHT 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 HTHT’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.
