The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Aker BP ASA’s (OB:AKERBP) P/E ratio could help you assess the value on offer. Based on the last twelve months, Aker BP’s P/E ratio is 42.59. That is equivalent to an earnings yield of about 2.3%.
How Do You Calculate Aker BP’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Aker BP:
P/E of 42.59 = $29.91 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.70 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each NOK1 the company has earned over the last year. 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 Aker BP Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (7.9) for companies in the oil and gas industry is a lot lower than Aker BP’s P/E.
Its relatively high P/E ratio indicates that Aker BP shareholders think it will perform better than other companies in its industry classification.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Aker BP saw earnings per share decrease by 44% last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Aker BP’s Balance Sheet
Aker BP’s net debt is 24% of its market cap. 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 Verdict On Aker BP’s P/E Ratio
Aker BP trades on a P/E ratio of 42.6, which is multiples above its market average of 13.7. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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 firstname.lastname@example.org. 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.