Westlake Chemical Partners LP (NYSE:WLKP) is currently trading at a trailing P/E of 15.2x, which is lower than the industry average of 21.2x. While this makes WLKP appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Westlake Chemical Partners

Breaking down the Price-Earnings ratio

A common ratio used for relative valuation is the P/E ratio. 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 WLKP

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

WLKP Price-Earnings Ratio = $24 ÷ $1.579 = 15.2x

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. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to WLKP, 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 WLKP’s P/E of 15.2x is lower than its industry peers (21.2x), it means that investors are paying less than they should for each dollar of WLKP’s earnings. Therefore, according to this analysis, WLKP is an under-priced stock.

Assumptions to be aware of

Before you jump to the conclusion that WLKP is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to WLKP, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with WLKP, 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 WLKP to are fairly valued by the market. If this does not hold, there is a possibility that WLKP’s P/E is lower because our peer group is overvalued by the market.

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.