The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in MPLX LP (NYSE:MPLX).
MPLX LP (NYSE:MPLX) is trading with a trailing P/E of 22.4x, which is higher than the industry average of 13.8x. 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. See our latest analysis for MPLX
Breaking down 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 MPLX
Price per share = $36.21
Earnings per share = $1.618
∴ Price-Earnings Ratio = $36.21 ÷ $1.618 = 22.4x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 MPLX, such as capital structure and profitability. 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.
Since MPLX's P/E of 22.4x is higher than its industry peers (13.8x), it means that investors are paying more than they should for each dollar of MPLX's earnings. Therefore, according to this analysis, MPLX is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your MPLX 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 MPLX. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with MPLX, then investors would naturally value MPLX at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with MPLX, investors would also value MPLX at a higher price since it is a higher growth investment. Both scenarios would explain why MPLX has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing MPLX to are fairly valued by the market. If this assumption is violated, MPLX's P/E may be higher than its peers because its peers are actually undervalued by investors.
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 MPLX. 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 MPLX’s future growth? Take a look at our free research report of analyst consensus for MPLX’s outlook.
- Past Track Record: Has MPLX 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 MPLX'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.
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Simply Wall St has no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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