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 Martin Midstream Partners LP (NASDAQ:MMLP)’s fundamentals and stock market performance.
Martin Midstream Partners LP (NASDAQ:MMLP) trades with a trailing P/E of 32.7x, which is higher than the industry average of 13.5x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View out our latest analysis for Martin Midstream Partners
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 MMLP
Price per share = $13.65
Earnings per share = $0.417
∴ Price-Earnings Ratio = $13.65 ÷ $0.417 = 32.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to MMLP, such as capital structure and profitability. 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.
Since MMLP’s P/E of 32.7x is higher than its industry peers (13.5x), it means that investors are paying more than they should for each dollar of MMLP’s earnings. This multiple is a median of profitable companies of 25 Oil and Gas companies in US including Energem Resources, Silver Star Energy and Far Vista Petroleum. As such, our analysis shows that MMLP represents an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that MMLP should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to MMLP. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with MMLP, then MMLP’s P/E would naturally be higher since investors would reward MMLP’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with MMLP, MMLP’s P/E would again be higher since investors would reward MMLP’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing MMLP to are fairly valued by the market. If this does not hold, there is a possibility that MMLP’s P/E is higher because firms in our peer group are being undervalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in MMLP. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 MMLP’s future growth? Take a look at our free research report of analyst consensus for MMLP’s outlook.
- Past Track Record: Has MMLP 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 MMLP’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.