I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Jura Energy Corporation (CVE:JEC) is trading with a trailing P/E of 3.6x, which is lower than the industry average of 20.5x. While this makes JEC appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for JEC
Price-Earnings Ratio = Price per share ÷ Earnings per share
JEC Price-Earnings Ratio = $0.054 ÷ $0.0149 = 3.6x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as JEC, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 3.6, JEC’s P/E is lower than its industry peers (20.5). This implies that investors are undervaluing each dollar of JEC’s earnings. This multiple is a median of profitable companies of 24 Oil and Gas companies in CA including Greencastle Resources, McChip Resources and Pinedale Energy. You can think of it like this: the market is suggesting that JEC is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to JEC, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with JEC, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing JEC to are fairly valued by the market. If this is violated, JEC’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to JEC. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
- Financial Health: Are JEC’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has JEC been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of JEC’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.