Should You Be Tempted To Sell Canadian Natural Resources Limited (TSE:CNQ) Because Of Its P/E Ratio?

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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how Canadian Natural Resources Limited’s (TSE:CNQ) P/E ratio could help you assess the value on offer. Based on the last twelve months, Canadian Natural Resources’s P/E ratio is 14.53. That corresponds to an earnings yield of approximately 6.9%.

Check out our latest analysis for Canadian Natural Resources

How Do I Calculate Canadian Natural Resources’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for Canadian Natural Resources:

P/E of 14.53 = CA$35.57 ÷ CA$2.45 (Based on the trailing twelve months to March 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 CA$1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Canadian Natural Resources increased earnings per share by 7.7% last year.

Does Canadian Natural Resources Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Canadian Natural Resources has a higher P/E than the average company (12.3) in the oil and gas industry.

TSX:CNQ Price Estimation Relative to Market, June 16th 2019
TSX:CNQ Price Estimation Relative to Market, June 16th 2019

Its relatively high P/E ratio indicates that Canadian Natural Resources shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Remember: P/E Ratios Don’t Consider The Balance Sheet

The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Canadian Natural Resources’s Balance Sheet

Net debt is 48% of Canadian Natural Resources’s market cap. While that’s enough to warrant consideration, it doesn’t really concern us.

The Bottom Line On Canadian Natural Resources’s P/E Ratio

Canadian Natural Resources’s P/E is 14.5 which is about average (15.1) in the CA market. When you consider the modest EPS growth last year (along with some debt), it seems the market thinks the growth is sustainable.

Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Canadian Natural Resources 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).

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.