This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Summit Midstream Partners LP (NYSE:SMLP)’s fundamentals and stock market performance.
Summit Midstream Partners LP (NYSE:SMLP) is trading with a trailing P/E of 18.3x, which is higher than the industry average of 13.3x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View out our latest analysis for Summit Midstream Partners
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 SMLP
Price-Earnings Ratio = Price per share ÷ Earnings per share
SMLP Price-Earnings Ratio = $15.6 ÷ $0.854 = 18.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to SMLP, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. SMLP’s P/E of 18.3x is higher than its industry peers (13.3x), which implies that each dollar of SMLP’s earnings is being overvalued by investors. As such, our analysis shows that SMLP represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your SMLP shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SMLP. 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 SMLP, 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 SMLP to are fairly valued by the market. If this does not hold, there is a possibility that SMLP’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in SMLP. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for SMLP’s future growth? Take a look at our free research report of analyst consensus for SMLP’s outlook.
- Past Track Record: Has SMLP 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 SMLP’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.