I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
FRP Holdings Inc (NASDAQ:FRPH) trades with a trailing P/E of 11.8x, which is lower than the industry average of 19.4x. 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.
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in 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 FRPH
Price-Earnings Ratio = Price per share ÷ Earnings per share
FRPH Price-Earnings Ratio = $48.72 ÷ $4.128 = 11.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 FRPH, 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. Since FRPH’s P/E of 11.8 is lower than its industry peers (19.4), it means that investors are paying less for each dollar of FRPH’s earnings. This multiple is a median of profitable companies of 24 Real Estate companies in US including Sunrise Real Estate Group, Altisource Portfolio Solutions and Kaanapali Land. You can think of it like this: the market is suggesting that FRPH is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to FRPH. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with FRPH, 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 FRPH to are fairly valued by the market. If this does not hold true, FRPH’s lower P/E ratio may be because firms in our peer group are 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 FRPH 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:
- Future Outlook: What are well-informed industry analysts predicting for FRPH’s future growth? Take a look at our free research report of analyst consensus for FRPH’s outlook.
- Past Track Record: Has FRPH 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 FRPH’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 past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.