Enbridge Income Fund Holdings Inc (TSX:ENF) is trading with a trailing P/E of 18.8x, which is lower than the industry average of 20.1x. While this makes ENF appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Enbridge Income Fund Holdings
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for ENF
Price per share = CA$28.29
Earnings per share = CA$1.508
∴ Price-Earnings Ratio = CA$28.29 ÷ CA$1.508 = 18.8x
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 ENF, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
ENF’s P/E of 18.8x is lower than its industry peers (20.1x), which implies that each dollar of ENF’s earnings is being undervalued by investors. Therefore, according to this analysis, ENF is an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy ENF, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to ENF. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with ENF, then ENF’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with ENF, ENF’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing ENF to are fairly valued by the market. If this assumption is violated, ENF’s P/E may be lower than its peers because its peers are actually overvalued by investors.
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 add more of ENF to your portfolio. 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:
- Future Outlook: What are well-informed industry analysts predicting for ENF’s future growth? Take a look at our free research report of analyst consensus for ENF’s outlook.
- Past Track Record: Has ENF 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 ENF’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.