Barnwell Industries Inc (AMEX:BRN) is currently trading at a trailing P/E of 14.7x, which is lower than the industry average of 14.7x. While this makes BRN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Barnwell Industries
Demystifying 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 BRN
Price-Earnings Ratio = Price per share ÷ Earnings per share
BRN Price-Earnings Ratio = $2.08 ÷ $0.141 = 14.7x
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 BRN, 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. BRN’s P/E of 14.7x is lower than its industry peers (14.7x), which implies that each dollar of BRN’s earnings is being undervalued by investors. Therefore, according to this analysis, BRN is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy BRN immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to BRN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with BRN, 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 BRN to are fairly valued by the market. If this does not hold, there is a possibility that BRN’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to BRN. 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.
Are you a potential investor? If BRN 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 Barnwell Industries 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.