This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Holly Energy Partners LP (NYSE:HEP)’s fundamentals and stock market performance.
Holly Energy Partners LP (NYSE:HEP) trades with a trailing P/E of 11.7x, which is lower than the industry average of 13.5x. While HEP might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Holly Energy Partners
What you need to know about the P/E 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for HEP
Price per share = $28.68
Earnings per share = $2.457
∴ Price-Earnings Ratio = $28.68 ÷ $2.457 = 11.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to HEP, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use below. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 11.7x, HEP’s P/E is lower than its industry peers (13.5x). This implies that investors are undervaluing each dollar of HEP’s earnings. This multiple is a median of profitable companies of 25 Oil and Gas companies in US including Energem Resources, Silver Star Energy and Far Vista Petroleum. As such, our analysis shows that HEP represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that HEP represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to HEP. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with HEP, then investors would naturally value HEP at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with HEP, investors would also value HEP at a lower price since it is a lower growth investment. Both scenarios would explain why HEP has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing HEP to are fairly valued by the market. If this does not hold, there is a possibility that HEP’s P/E is lower because firms in our peer group are being 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 undervaluation could signal a good buying opportunity to increase your exposure to HEP. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for HEP’s future growth? Take a look at our free research report of analyst consensus for HEP’s outlook.
- Past Track Record: Has HEP 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 HEP’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.