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Hess Midstream Partners LP (NYSE:HESM) trades with a trailing P/E of 27x, which is higher than the industry average of 12.8x. 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 explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Hess Midstream Partners
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 HESM
Price-Earnings Ratio = Price per share ÷ Earnings per share
HESM Price-Earnings Ratio = $20.25 ÷ $0.751 = 27x
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 HESM, 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. At 27x, HESM’s P/E is higher than its industry peers (12.8x). This implies that investors are overvaluing each dollar of HESM’s earnings. As such, our analysis shows that HESM represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your HESM shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to HESM. 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 HESM, 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 HESM to are fairly valued by the market. If this does not hold true, HESM’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to HESM. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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: