This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Five Point Holdings LLC (NYSE:FPH) is currently trading at a trailing P/E of 8.9x, which is higher than the industry average of 8.8x. While this makes FPH 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. 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 FPH
Price-Earnings Ratio = Price per share ÷ Earnings per share
FPH Price-Earnings Ratio = $11.06 ÷ $1.24 = 8.9x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as FPH, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since FPH’s P/E of 8.9x is higher than its industry peers (8.8x), it means that investors are paying more than they should for each dollar of FPH’s earnings. This multiple is a median of profitable companies of 25 Real Estate companies in US including Sunrise Real Estate Group, Guangzhou R&F Properties and Guangzhou R&F Properties. As such, our analysis shows that FPH represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your FPH shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to FPH, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with FPH, 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 FPH to are fairly valued by the market. If this is violated, FPH’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to FPH. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 FPH’s future growth? Take a look at our free research report of analyst consensus for FPH’s outlook.
- Financial Health: Are FPH’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- 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.