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Black Stone Minerals LP. (NYSE:BSM) is trading with a trailing P/E of 28.2x, which is higher than the industry average of 14.4x. 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. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Black Stone Minerals
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 BSM
Price-Earnings Ratio = Price per share ÷ Earnings per share
BSM Price-Earnings Ratio = $18.62 ÷ $0.66 = 28.2x
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 BSM, 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 BSM’s P/E of 28.2x is higher than its industry peers (14.4x), it means that investors are paying more than they should for each dollar of BSM’s earnings. As such, our analysis shows that BSM represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your BSM shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to BSM. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with BSM, 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 BSM to are fairly valued by the market. If this does not hold true, BSM’s lower P/E ratio may be because firms in our peer group are 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 BSM. 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 urge you to complete your research by taking a look at the following: