Sabine Royalty Trust (NYSE:SBR) trades with a trailing P/E of 20.6x, which is higher than the industry average of 13.9x. 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Sabine Royalty Trust
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 SBR
Price per share = $49.15
Earnings per share = $2.391
∴ Price-Earnings Ratio = $49.15 ÷ $2.391 = 20.6x
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 SBR, such as capital structure and profitability. 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.
SBR’s P/E of 20.6x is higher than its industry peers (13.9x), which implies that each dollar of SBR’s earnings is being overvalued by investors. As such, our analysis shows that SBR represents an over-priced stock.
A few caveats
However, before you rush out to sell your SBR 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 SBR. 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 SBR, then SBR’s P/E would naturally be higher since investors would reward SBR’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with SBR, SBR’s P/E would again be higher since investors would reward SBR’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing SBR to are fairly valued by the market. If this assumption does not hold true, SBR’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.
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 SBR. 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:
- Financial Health: Is SBR’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.
- Past Track Record: Has SBR 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 SBR’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.