Capital Product Partners LP (NASDAQ:CPLP) is trading with a trailing P/E of 12.6x, which is lower than the industry average of 14.8x. While this makes CPLP appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Capital Product Partners
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 CPLP
Price per share = $3.44
Earnings per share = $0.274
∴ Price-Earnings Ratio = $3.44 ÷ $0.274 = 12.6x
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 CPLP, 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 similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
CPLP’s P/E of 12.6x is lower than its industry peers (14.8x), which implies that each dollar of CPLP’s earnings is being undervalued by investors. As such, our analysis shows that CPLP represents an under-priced stock.
A few caveats
Before you jump to the conclusion that CPLP represents the perfect buying opportunity, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to CPLP. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with CPLP, then investors would naturally value CPLP at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with CPLP, investors would also value CPLP at a lower price since it is a lower growth investment. Both scenarios would explain why CPLP has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing CPLP to are fairly valued by the market. If this assumption is violated, CPLP’s P/E may be lower than its peers because its peers are actually overvalued by investors.
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 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 urge you to complete your research by taking a look at the following:
- 1. 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.
- 2. 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.
- 3. 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.