TC PipeLines LP (NYSE:TCP) trades with a trailing P/E of 9.7x, which is lower than the industry average of 12.5x. While this makes TCP 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 break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for TC PipeLines
What you need to know about the P/E 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 TCP
Price per share = $30.81
Earnings per share = $3.165
∴ Price-Earnings Ratio = $30.81 ÷ $3.165 = 9.7x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to TCP, such as company lifetime and products sold. 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 TCP’s P/E of 9.7x is lower than its industry peers (12.5x), it means that investors are paying less than they should for each dollar of TCP’s earnings. As such, our analysis shows that TCP represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy TCP, 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 TCP. 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 TCP, then investors would naturally value TCP at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with TCP, investors would also value TCP at a lower price since it is a lower growth investment. Both scenarios would explain why TCP has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing TCP to are fairly valued by the market. If this assumption does not hold true, TCP’s lower P/E ratio may be 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 TCP. 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 TCP’s future growth? Take a look at our free research report of analyst consensus for TCP’s outlook.
- Past Track Record: Has TCP 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 TCP’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.