At $31.9, Is It Time To Sell Dominion Energy Midstream Partners LP (DM)?
Dominion Energy Midstream Partners LP (NYSE:DM) is currently trading at a trailing P/E of 22.7x, which is higher than the industry average of 21x. 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 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 Dominion Energy Midstream Partners
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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.
P/E Calculation for DM
Price-Earnings Ratio = Price per share ÷ Earnings per share
DM Price-Earnings Ratio = 31.9 ÷ 1.405 = 22.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to DM, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 22.7x, DM’s P/E is higher than its industry peers (21x). This implies that investors are overvaluing each dollar of DM’s earnings. Therefore, according to this analysis, DM is an over-priced stock.
A few caveats
Before you jump to the conclusion that DM should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to DM, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with DM, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing DM to are fairly valued by the market. If this does not hold, there is a possibility that DM’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on DM, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I've outlined above.
Are you a potential investor? If you are considering investing in DM, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Dominion Energy Midstream Partners for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
