The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Tidewater Midstream and Infrastructure Ltd (TSE:TWM)’s fundamentals and stock market performance.
Tidewater Midstream and Infrastructure Ltd (TSE:TWM) trades with a trailing P/E of 40.6x, which is higher than the industry average of 19.7x. While TWM might seem like a stock to avoid or sell if you own it, 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 out our latest analysis for Tidewater Midstream and Infrastructure
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 TWM
Price per share = CA$1.25
Earnings per share = CA$0.0308
∴ Price-Earnings Ratio = CA$1.25 ÷ CA$0.0308 = 40.6x
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 TWM, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll 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.
TWM’s P/E of 40.6x is higher than its industry peers (19.7x), which implies that each dollar of TWM’s earnings is being overvalued by investors. Therefore, according to this analysis, TWM is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your TWM shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to TWM. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared riskier firms with TWM, then investors would naturally value TWM at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with TWM, investors would also value TWM at a higher price since it is a higher growth investment. Both scenarios would explain why TWM has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing TWM to are fairly valued by the market. If this assumption is violated, TWM’s P/E may be higher than its peers because its peers are actually undervalued by investors.
What this means for you:
Since you may have already conducted your due diligence on TWM, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 TWM’s future growth? Take a look at our free research report of analyst consensus for TWM’s outlook.
- Financial Health: Is TWM’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.
- 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.