Universal Health Realty Income Trust (NYSE:UHT) is currently trading at a trailing P/E of 23.1x, which is lower than the industry average of 49.8x. 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. View our latest analysis for Universal Health Realty Income Trust
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for UHT
Price per share = 74.55
Earnings per share = 3.23
∴ Price-Earnings Ratio = 74.55 ÷ 3.23 = 23.1x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to UHT, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 23.1x, UHT’s P/E is lower than its industry peers (49.8x). This implies that investors are undervaluing each dollar of UHT’s earnings. Therefore, according to this analysis, UHT is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy UHT immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to UHT. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you accidentally compared higher growth firms with UHT, then UHT’s P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. Alternatively, if you inadvertently compared less risky firms with UHT, UHT’s P/E would again be lower since investors would reward its peers’ lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing UHT to are fairly valued by the market. If this assumption does not hold true, UHT’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of UHT to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in UHT, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 Universal Health Realty Income Trust 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.