Despite Its High P/E Ratio, Is Exxon Mobil Corporation (NYSE:XOM) Still Undervalued?

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Exxon Mobil Corporation’s (NYSE:XOM) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, Exxon Mobil has a P/E ratio of 16.25. That corresponds to an earnings yield of approximately 6.2%.

Check out our latest analysis for Exxon Mobil

How Do You Calculate Exxon Mobil’s P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Exxon Mobil:

P/E of 16.25 = $67.44 ÷ $4.15 (Based on the year to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

Does Exxon Mobil Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Exxon Mobil has a higher P/E than the average company (9.6) in the oil and gas industry.

NYSE:XOM Price Estimation Relative to Market, October 10th 2019
NYSE:XOM Price Estimation Relative to Market, October 10th 2019

Exxon Mobil’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. Earnings growth means that in the future the ‘E’ will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Exxon Mobil’s earnings per share fell by 15% in the last twelve months. But it has grown its earnings per share by 18% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 12% annually. This could justify a pessimistic P/E.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Exxon Mobil’s Debt Impact Its P/E Ratio?

Exxon Mobil has net debt worth 14% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Bottom Line On Exxon Mobil’s P/E Ratio

Exxon Mobil’s P/E is 16.3 which is about average (17.3) in the US market. With modest debt, and a lack of recent growth, it would seem the market is expecting improvement in earnings.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than Exxon Mobil. So you may wish to see this free collection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.