Green Plains Partners LP (NASDAQ:GPP) is trading with a trailing P/E of 10.2x, which is lower than the industry average of 14x. While GPP might seem like an attractive stock to buy, 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. See our latest analysis for Green Plains Partners
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 GPP
Price per share = $18.55
Earnings per share = $1.817
∴ Price-Earnings Ratio = $18.55 ÷ $1.817 = 10.2x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as GPP, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. 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.
GPP’s P/E of 10.2x is lower than its industry peers (14x), which implies that each dollar of GPP’s earnings is being undervalued by investors. As such, our analysis shows that GPP represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that GPP 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 GPP. 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 lower risk firms with GPP, then GPP’s P/E would naturally be lower than its peers, since investors would value those with lower risk with a higher price. The other possibility is if you were accidentally comparing higher growth firms with GPP. In this case, GPP’s P/E would be lower since investors would also reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing GPP to are fairly valued by the market. If this assumption is violated, GPP’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 GPP. 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:
1. Future Outlook: What are well-informed industry analysts predicting for GPP’s future growth? Take a look at our free research report of analyst consensus for GPP’s outlook.
2. Financial Health: Is GPP’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.
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.