Marine Products Corporation (NYSE:MPX) is currently trading at a trailing P/E of 31.6x, which is higher than the industry average of 18.4x. While this makes MPX appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Marine Products

Breaking down the P/E ratio

P/E is a popular ratio used for relative valuation. 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.

P/E Calculation for MPX

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

MPX Price-Earnings Ratio = 16.93 ÷ 0.536 = 31.6x

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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to MPX, 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. At 31.6x, MPX’s P/E is higher than its industry peers (18.4x). This implies that investors are overvaluing each dollar of MPX’s earnings. Therefore, according to this analysis, MPX is an over-priced stock.

A few caveats

While our conclusion might prompt you to sell your MPX shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to MPX, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with MPX, 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 MPX to are fairly valued by the market. If this does not hold, there is a possibility that MPX’s P/E is lower because our peer group is overvalued by the market.

What this means for you:

Are you a shareholder? 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 MPX. 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.

Are you a potential investor? If MPX has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.