MPLX LP (NYSE:MPLX) is currently trading at a trailing P/E of 21.5x, which is higher than the industry average of 14x. While MPLX might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 MPLX
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 MPLX
Price per share = $34.79
Earnings per share = $1.618
∴ Price-Earnings Ratio = $34.79 ÷ $1.618 = 21.5x
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. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to MPLX, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use below. 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.
At 21.5x, MPLX’s P/E is higher than its industry peers (14x). This implies that investors are overvaluing each dollar of MPLX’s earnings. As such, our analysis shows that MPLX represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your MPLX shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to MPLX. 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 riskier firms with MPLX, then MPLX’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with MPLX. In this case, MPLX’s P/E would be higher since investors would also reward MPLX’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing MPLX to are fairly valued by the market. If this does not hold, there is a possibility that MPLX’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 MPLX. 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 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.