Here’s How P/E Ratios Can Help Us Understand Eland Oil & Gas PLC (LON:ELA)

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Eland Oil & Gas PLC’s (LON:ELA) P/E ratio to inform your assessment of the investment opportunity. What is Eland Oil & Gas’s P/E ratio? Well, based on the last twelve months it is 5.31. That means that at current prices, buyers pay £5.31 for every £1 in trailing yearly profits.

View our latest analysis for Eland Oil & Gas

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Eland Oil & Gas:

P/E of 5.31 = $1.47 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.28 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.

How Does Eland Oil & Gas’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Eland Oil & Gas has a lower P/E than the average (8.3) P/E for companies in the oil and gas industry.

AIM:ELA Price Estimation Relative to Market, August 9th 2019
AIM:ELA Price Estimation Relative to Market, August 9th 2019

This suggests that market participants think Eland Oil & Gas will underperform other companies in its industry.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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.

Eland Oil & Gas’s earnings made like a rocket, taking off 385% last year. The cherry on top is that the five year growth rate was an impressive 81% per year. With that kind of growth rate we would generally expect a high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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).

Is Debt Impacting Eland Oil & Gas’s P/E?

Net debt totals just 1.3% of Eland Oil & Gas’s market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Eland Oil & Gas’s P/E Ratio

Eland Oil & Gas’s P/E is 5.3 which is below average (16) in the GB market. The EPS growth last year was strong, and debt levels are quite reasonable. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.