Should We Worry About Evolution Petroleum Corporation’s (NYSEMKT:EPM) P/E Ratio?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Evolution Petroleum Corporation’s (NYSEMKT:EPM) P/E ratio to inform your assessment of the investment opportunity. Evolution Petroleum has a P/E ratio of 12.23, based on the last twelve months. That is equivalent to an earnings yield of about 8.2%.

See our latest analysis for Evolution Petroleum

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Evolution Petroleum:

P/E of 12.23 = $5.67 ÷ $0.46 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

Does Evolution Petroleum 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, Evolution Petroleum has a higher P/E than the average company (9.9) in the oil and gas industry.

AMEX:EPM Price Estimation Relative to Market, October 8th 2019
AMEX:EPM Price Estimation Relative to Market, October 8th 2019

Its relatively high P/E ratio indicates that Evolution Petroleum shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

Evolution Petroleum shrunk earnings per share by 22% over the last year. But over the longer term (5 years) earnings per share have increased by 37%. And EPS is down 14% a year, over the last 3 years. This growth rate might warrant a low 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. Thus, the metric does not reflect cash or debt held by the company. 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).

So What Does Evolution Petroleum’s Balance Sheet Tell Us?

With net cash of US$32m, Evolution Petroleum has a very strong balance sheet, which may be important for its business. Having said that, at 17% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Evolution Petroleum’s P/E Ratio

Evolution Petroleum’s P/E is 12.2 which is below average (17.6) in the US market. The recent drop in earnings per share would almost certainly temper expectations, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Evolution Petroleum. 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.