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Should You Be Tempted To Sell CITIC Limited (HKG:267) Because Of Its P/E Ratio?

I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

CITIC Limited (HKG:267) trades with a trailing P/E of 8, which is higher than the industry average of 7.1. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.

View our latest analysis for CITIC

Breaking down the P/E ratio

SEHK:267 PE PEG Gauge October 30th 18
SEHK:267 PE PEG Gauge October 30th 18

The P/E ratio is one of many ratios used in 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 dollar of the company’s earnings.

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P/E Calculation for 267

Price-Earnings Ratio = Price per share ÷ Earnings per share

267 Price-Earnings Ratio = HK$11.66 ÷ HK$1.455 = 8x

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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to 267, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since 267’s P/E of 8 is higher than its industry peers (7.1), it means that investors are paying more for each dollar of 267’s earnings. This multiple is a median of profitable companies of 10 Industrials companies in HK including Chevalier International Holdings, Chongqing Machinery & Electric and Shanghai Industrial Holdings. You could think of it like this: the market is pricing 267 as if it is a stronger company than the average of its industry group.

Assumptions to be aware of

However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to 267. If this isn’t the case, the difference in P/E could be due to other factors. For example, if CITIC 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 267 may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.

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 267. 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 highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for 267’s future growth? Take a look at our free research report of analyst consensus for 267’s outlook.

  2. Past Track Record: Has 267 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 267’s historicals for more clarity.

  3. 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 editorial-team@simplywallst.com.