Should You Sell MGP Ingredients Inc (MGPI) At $60.63?
MGP Ingredients Inc (NASDAQ:MGPI) is trading with a trailing P/E of 31.7x, which is higher than the industry average of 27x. While this makes MGPI appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. 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 MGPI
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 MGPI
Price-Earnings Ratio = Price per share ÷ Earnings per share
MGPI Price-Earnings Ratio = 60.63 ÷ 1.915 = 31.7x
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 MGPI, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since MGPI's P/E of 31.7x is higher than its industry peers (27x), it means that investors are paying more than they should for each dollar of MGPI's earnings. Therefore, according to this analysis, MGPI is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your MGPI shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to MGPI, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with MGPI, 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 MGPI to are fairly valued by the market. If this is violated, MGPI's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in MGPI. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If MGPI has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 MGP Ingredients 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.
