This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Storm Resources Ltd.’s (TSE:SRX), to help you decide if the stock is worth further research. Storm Resources has a P/E ratio of 7.6, based on the last twelve months. That corresponds to an earnings yield of approximately 13%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Storm Resources:
P/E of 7.6 = CA$2.01 ÷ CA$0.26 (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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Most would be impressed by Storm Resources earnings growth of 15% in the last year.
Does Storm 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 Storm Resources has a lower P/E than the average (14.3) P/E for companies in the oil and gas industry.
Storm Resources’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Storm Resources, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. That means it doesn’t take debt or cash into account. 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).
Storm Resources’s Balance Sheet
Net debt is 38% of Storm Resources’s market cap. You’d want to be aware of this fact, but it doesn’t bother us.
The Bottom Line On Storm Resources’s P/E Ratio
Storm Resources’s P/E is 7.6 which is below average (14.9) in the CA market. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Storm 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 email@example.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.