MLP SE (DB:MLP) is trading with a trailing P/E of 19.7x, which is higher than the industry average of 16.6x. While this makes MLP 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. View our latest analysis for MLP
Demystifying 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 MLP
Price per share = €5.02
Earnings per share = €0.254
∴ Price-Earnings Ratio = €5.02 ÷ €0.254 = 19.7x
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. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to MLP, 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.
Since MLP’s P/E of 19.7x is higher than its industry peers (16.6x), it means that investors are paying more than they should for each dollar of MLP’s earnings. Therefore, according to this analysis, MLP is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your MLP shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to MLP. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing riskier firms with MLP, then MLP’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with MLP. In this case, MLP’s P/E would be higher since investors would also reward MLP’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing MLP to are fairly valued by the market. If this assumption is violated, MLP’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 MLP, 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 MLP’s future growth? Take a look at our free research report of analyst consensus for MLP’s outlook.
- Past Track Record: Has MLP 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 MLP’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.