Four Corners Property Trust Inc (NYSE:FCPT) trades with a trailing P/E of 18.6x, which is lower than the industry average of 49.1x. While FCPT might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Four Corners Property Trust

Breaking down the Price-Earnings ratio

P/E is often used for relative valuation since earnings power is a chief 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.

Formula

Price-Earnings Ratio = Price per share ÷ Earnings per share

P/E Calculation for FCPT

Price per share = 25.3

Earnings per share = 1.359

∴ Price-Earnings Ratio = 25.3 ÷ 1.359 = 18.6x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to FCPT, such as company lifetime and products sold. 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.

Since FCPT's P/E of 18.6x is lower than its industry peers (49.1x), it means that investors are paying less than they should for each dollar of FCPT's earnings. Therefore, according to this analysis, FCPT is an under-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to buy FCPT 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 FCPT. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with FCPT, then investors would naturally value FCPT at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with FCPT, investors would also value FCPT at a lower price since it is a lower growth investment. Both scenarios would explain why FCPT has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing FCPT to are fairly valued by the market. If this does not hold, there is a possibility that FCPT’s P/E is lower 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 FCPT 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 FCPT, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.

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 Four Corners Property 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.