Universal Health Realty Income Trust (NYSE:UHT) trades with a trailing P/E of 22.6x, which is lower than the industry average of 30.4x. Although some investors may jump to the conclusion that this is a great buying opportunity, 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. See our latest analysis for Universal Health Realty Income Trust
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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.
P/E Calculation for UHT
Price-Earnings Ratio = Price per share ÷ Earnings per share
UHT Price-Earnings Ratio = $73.28 ÷ $3.238 = 22.6x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to UHT, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since UHT’s P/E of 22.6x is lower than its industry peers (30.4x), it means that investors are paying less than they should for each dollar of UHT’s earnings. As such, our analysis shows that UHT represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that UHT is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to UHT. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with UHT, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing UHT to are fairly valued by the market. If this does not hold, there is a possibility that UHT’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 UHT, the undervaluation of the stock may mean it is a good time to top up on 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 UHT, 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 Universal Health Realty Income Trust 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.