Cross Timbers Royalty Trust (NYSE:CRT) trades with a trailing P/E of 12.4x, which is lower than the industry average of 13.8x. While CRT might seem like an attractive stock to buy, 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 Cross Timbers Royalty Trust
Demystifying the P/E ratio
P/E is a popular ratio used for 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.
P/E Calculation for CRT
Price-Earnings Ratio = Price per share ÷ Earnings per share
CRT Price-Earnings Ratio = $13.9 ÷ $1.117 = 12.4x
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 CRT, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 12.4x, CRT’s P/E is lower than its industry peers (13.8x). This implies that investors are undervaluing each dollar of CRT’s earnings. As such, our analysis shows that CRT represents an under-priced stock.
A few caveats
However, before you rush out to buy CRT, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to CRT. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with CRT, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing CRT to are fairly valued by the market. If this does not hold, there is a possibility that CRT’s P/E is lower because our peer group is overvalued 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 add more of CRT to your portfolio. 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:
- Financial Health: Is CRT’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 CRT 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 CRT’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.
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.