BP Prudhoe Bay Royalty Trust (NYSE:BPT) is currently trading at a trailing P/E of 7.3x, which is lower than the industry average of 13.9x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for BP Prudhoe Bay Royalty Trust
What you need to know about the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 BPT
Price-Earnings Ratio = Price per share ÷ Earnings per share
BPT Price-Earnings Ratio = $28.15 ÷ $3.836 = 7.3x
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 BPT, 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. At 7.3x, BPT’s P/E is lower than its industry peers (13.9x). This implies that investors are undervaluing each dollar of BPT’s earnings. As such, our analysis shows that BPT represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy BPT immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to BPT, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with BPT, 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 BPT to are fairly valued by the market. If this does not hold, there is a possibility that BPT’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on BPT, the undervaluation of the stock may mean it is a good time to top up on 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:
- Financial Health: Is BPT’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.
- Past Track Record: Has BPT 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 BPT’s historicals for more clarity.
- 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 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.