Star Group LP (NYSE:SGU) is trading with a trailing P/E of 23.3x, which is higher than the industry average of 22.2x. While SGU might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Star Group
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 SGU
Price-Earnings Ratio = Price per share ÷ Earnings per share
SGU Price-Earnings Ratio = $10.76 ÷ $0.462 = 23.3x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SGU, 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. Since SGU’s P/E of 23.3x is higher than its industry peers (22.2x), it means that investors are paying more than they should for each dollar of SGU’s earnings. Therefore, according to this analysis, SGU is an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your SGU shares, 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 SGU, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with SGU, 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 SGU to are fairly valued by the market. If this is violated, SGU’s P/E may be lower than its peers as they are actually overvalued by investors.
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.