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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 NuVista Energy Ltd.’s (TSE:NVA) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, NuVista Energy has a P/E ratio of 6.31. That is equivalent to an earnings yield of about 16%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for NuVista Energy:
P/E of 6.31 = CA$4.51 ÷ CA$0.71 (Based on the year to December 2018.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
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. 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.
It’s nice to see that NuVista Energy grew EPS by a stonking 31% in the last year.
Does NuVista Energy 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. If you look at the image below, you can see NuVista Energy has a lower P/E than the average (16.4) in the oil and gas industry classification.
This suggests that market participants think NuVista Energy will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
NuVista Energy’s Balance Sheet
Net debt is 46% of NuVista Energy’s market cap. You’d want to be aware of this fact, but it doesn’t bother us.
The Verdict On NuVista Energy’s P/E Ratio
NuVista Energy trades on a P/E ratio of 6.3, which is below the CA market average of 15.1. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
Investors have an opportunity when market expectations about a stock are wrong. 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.
You might be able to find a better buy than NuVista Energy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 firstname.lastname@example.org. 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.