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Should You Be Tempted To Sell Permian Basin Royalty Trust (NYSE:PBT) Because Of Its PE Ratio?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.

Permian Basin Royalty Trust (NYSE:PBT) is currently trading at a trailing P/E of 13.3, which is higher than the industry average of 12.5. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.

View our latest analysis for Permian Basin Royalty Trust

Breaking down the P/E ratio

NYSE:PBT PE PEG Gauge September 18th 18
NYSE:PBT PE PEG Gauge September 18th 18

P/E is often used for relative valuation since earnings power is a chief 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 PBT

Price-Earnings Ratio = Price per share ÷ Earnings per share

PBT Price-Earnings Ratio = $8.42 ÷ $0.633 = 13.3x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to PBT, 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. PBT’s P/E of 13.3 is higher than its industry peers (12.5), which implies that each dollar of PBT’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Oil and Gas companies in US including Energem Resources, Longwei Petroleum Investment Holding and Petrosibir. You could think of it like this: the market is pricing PBT as if it is a stronger company than the average of its industry group.

Assumptions to watch out for

However, you should be aware that this analysis makes certain assumptions. The first is that our “similar companies” are actually similar to PBT. If not, the difference in P/E might be a result of other factors. For example, if Permian Basin Royalty Trust is growing faster than its peers, then it would deserve a higher P/E ratio. We should also be aware that the stocks we are comparing to PBT may not be fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.

What this means for you:

Since you may have already conducted your due diligence on PBT, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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:

  1. Financial Health: Are PBT’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.

  2. Past Track Record: Has PBT 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 PBT’s historicals for more clarity.

  3. 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 editorial-team@simplywallst.com.