ECA Marcellus Trust I (NYSE:ECT) is currently trading at a trailing P/E of 5.1x, which is lower than the industry average of 13.3x. 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. In this article, 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 ECA Marcellus Trust I
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. 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 ECT
Price-Earnings Ratio = Price per share ÷ Earnings per share
ECT Price-Earnings Ratio = $1.65 ÷ $0.326 = 5.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ECT, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. ECT’s P/E of 5.1x is lower than its industry peers (13.3x), which implies that each dollar of ECT’s earnings is being undervalued by investors. As such, our analysis shows that ECT represents an under-priced stock.
A few caveats
However, before you rush out to buy ECT, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to ECT, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with ECT, 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 ECT to are fairly valued by the market. If this does not hold, there is a possibility that ECT’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 ECT, 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 ECT’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 ECT 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 ECT’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.