Star Group LP (NYSE:SGU) is trading with a trailing P/E of 23.3x, which is higher than the industry average of 22.2x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Star Group
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 SGU
Price per share = $10.76
Earnings per share = $0.462
∴ Price-Earnings Ratio = $10.76 ÷ $0.462 = 23.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SGU, such as size and country of operation. 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.
At 23.3x, SGU’s P/E is higher than its industry peers (22.2x). This implies that investors are overvaluing each dollar of SGU’s earnings. As such, our analysis shows that SGU represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that SGU should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to SGU. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared lower growth firms with SGU, then SGU’s P/E would naturally be higher since investors would reward SGU’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with SGU, SGU’s P/E would again be higher since investors would reward SGU’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing SGU to are fairly valued by the market. If this assumption is violated, SGU’s P/E may be higher than its peers because its peers are actually undervalued by investors.
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 SGU. 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:
- 1. Financial Health: Is SGU’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.
- 2. Past Track Record: Has SGU 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 SGU’s historicals for more clarity.
- 3. 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.