I am writing today to help inform people who are new to the stock market and want to begin learning the link between Green Plains Partners LP (NASDAQ:GPP)’s fundamentals and stock market performance.
Green Plains Partners LP (NASDAQ:GPP) is trading with a trailing P/E of 9.9x, which is lower than the industry average of 13.8x. While this makes GPP 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Green Plains Partners
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for 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 GPP
Price per share = $17.45
Earnings per share = $1.764
∴ Price-Earnings Ratio = $17.45 ÷ $1.764 = 9.9x
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 quick method of creating a peer group is to use companies in the same industry, which is what I will 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.
GPP’s P/E of 9.9x is lower than its industry peers (13.8x), 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
While our conclusion might prompt you to buy GPP immediately, there are two important assumptions you should be aware of. 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 inadvertently compared lower risk firms with GPP, then investors would naturally value GPP at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with GPP, investors would also value GPP at a lower price since it is a lower growth investment. Both scenarios would explain why GPP has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing GPP to are fairly valued by the market. If this does not hold, there is a possibility that GPP’s P/E is lower because firms in our peer group are being overvalued by the market.
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:
- 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.
- 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.
- 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.