Marathon Oil (NYSE:MRO) shareholders are no doubt pleased to see that the share price has bounced 40% in the last month alone, although it is still down 58% over the last quarter. But that will do little to salve the savage burn caused by the 71% share price decline, over the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Check out our latest analysis for Marathon Oil
Does Marathon Oil Have A Relatively High Or Low P/E For Its Industry?
Marathon Oil has a P/E ratio of 8.32. You can see in the image below that the average P/E (8.5) for companies in the oil and gas industry is roughly the same as Marathon Oil’s P/E.
That indicates that the market expects Marathon Oil will perform roughly in line with other companies in its industry. So if Marathon Oil actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.
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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
Marathon Oil shrunk earnings per share by 54% over the last year. And over the longer term (5 years) earnings per share have decreased 16% annually. This growth rate might warrant a below average 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. 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.
Is Debt Impacting Marathon Oil’s P/E?
Marathon Oil’s net debt is considerable, at 119% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On Marathon Oil’s P/E Ratio
Marathon Oil trades on a P/E ratio of 8.3, which is below the US market average of 13.5. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. What we know for sure is that investors are becoming less uncomfortable about Marathon Oil’s prospects, since they have pushed its P/E ratio from 5.9 to 8.3 over the last month. For those who like to invest in turnarounds, that might mean it’s time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.
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.
But note: Marathon Oil may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.
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