MFA Financial Inc (NYSE:MFA) trades with a trailing P/E of 9.7x, which is lower than the industry average of 9.8x. While this makes MFA appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 MFA Financial
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 MFA
Price-Earnings Ratio = Price per share ÷ Earnings per share
MFA Price-Earnings Ratio = $7.12 ÷ $0.73 = 9.7x
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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to MFA, 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. At 9.7x, MFA’s P/E is lower than its industry peers (9.8x). This implies that investors are undervaluing each dollar of MFA’s earnings. Therefore, according to this analysis, MFA is an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that MFA is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to MFA, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MFA, 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 MFA to are fairly valued by the market. If this is violated, MFA’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.