Does Oil Search Limited's (ASX:OSH) PE Ratio Signal A Selling Opportunity?

Oil Search Limited (ASX:OSH) is trading with a trailing P/E of 45.6x, which is higher than the industry average of 11.2x. While OSH might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Oil Search

What you need to know about the P/E ratio

P/E is a popular ratio used for relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as OSH, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.

OSH’s P/E of 45.6x is higher than its industry peers (11.2x), which implies that each dollar of OSH’s earnings is being overvalued by investors. Therefore, according to this analysis, OSH is an over-priced stock.

Assumptions to watch out for

However, before you rush out to sell your OSH shares, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to OSH. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with OSH, then investors would naturally value OSH at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with OSH, investors would also value OSH at a higher price since it is a higher growth investment. Both scenarios would explain why OSH has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing OSH to are fairly valued by the market. If this does not hold, there is a possibility that OSH’s P/E is higher because firms in our peer group are being undervalued by the market.

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to OSH. 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:

• 1. Future Outlook: What are well-informed industry analysts predicting for OSH’s future growth? Take a look at our free research report of analyst consensus for OSH’s outlook.
• 2. Past Track Record: Has OSH 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 OSH's historicals for more clarity.
• 3. 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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.