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 Capital Product Partners LP (NASDAQ:CPLP)’s fundamentals and stock market performance.
Capital Product Partners LP (NASDAQ:CPLP) is currently trading at a trailing P/E of 19.3x, which is higher than the industry average of 13.4x. While CPLP 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View out our latest analysis for Capital Product Partners
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 CPLP
Price per share = $3.06
Earnings per share = $0.159
∴ Price-Earnings Ratio = $3.06 ÷ $0.159 = 19.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CPLP, such as size and country of operation. 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.
At 19.3x, CPLP’s P/E is higher than its industry peers (13.4x). This implies that investors are overvaluing each dollar of CPLP’s earnings. Therefore, according to this analysis, CPLP is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your CPLP shares immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to CPLP. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing riskier firms with CPLP, then CPLP’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 CPLP. In this case, CPLP’s P/E would be higher since investors would also reward CPLP’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CPLP to are fairly valued by the market. If this does not hold, there is a possibility that CPLP’s P/E is higher because firms in our peer group are being undervalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to CPLP. 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 CPLP’s future growth? Take a look at our free research report of analyst consensus for CPLP’s outlook.
- Past Track Record: Has CPLP 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 CPLP’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.