San Juan Basin Royalty Trust (NYSE:SJT) trades with a trailing P/E of 11x, which is lower than the industry average of 13.1x. While SJT 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 explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for San Juan Basin Royalty Trust
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 SJT
Price-Earnings Ratio = Price per share ÷ Earnings per share
SJT Price-Earnings Ratio = $8.66 ÷ $0.786 = 11x
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 SJT, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 11x, SJT’s P/E is lower than its industry peers (13.1x). This implies that investors are undervaluing each dollar of SJT’s earnings. As such, our analysis shows that SJT represents an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that SJT 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 SJT. 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 SJT, 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 SJT to are fairly valued by the market. If this is violated, SJT’s P/E may be lower than its peers as they are actually overvalued by investors.
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.