Why ARC Resources Ltd.’s (TSE:ARX) High P/E Ratio Isn’t Necessarily A Bad Thing

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how ARC Resources Ltd.’s (TSE:ARX) P/E ratio could help you assess the value on offer. What is ARC Resources’s P/E ratio? Well, based on the last twelve months it is 21.52. That means that at current prices, buyers pay CA$21.52 for every CA$1 in trailing yearly profits.

See our latest analysis for ARC Resources

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for ARC Resources:

P/E of 21.52 = CA$6.35 ÷ CA$0.30 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CA$1 of company earnings. 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 ARC Resources Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that ARC Resources has a higher P/E than the average (13) P/E for companies in the oil and gas industry.

TSX:ARX Price Estimation Relative to Market, July 22nd 2019
TSX:ARX Price Estimation Relative to Market, July 22nd 2019

Its relatively high P/E ratio indicates that ARC Resources shareholders think it will perform better than other companies in its industry classification.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

ARC Resources’s earnings per share fell by 65% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 16% annually. This might lead to muted expectations.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won’t reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Is Debt Impacting ARC Resources’s P/E?

Net debt is 33% of ARC Resources’s market cap. While it’s worth keeping this in mind, it isn’t a worry.

The Bottom Line On ARC Resources’s P/E Ratio

ARC Resources has a P/E of 21.5. That’s higher than the average in its market, which is 15.5. With some debt but no EPS growth last year, the market has high expectations of future profits.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than ARC Resources. 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.