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 Tourmaline Oil Corp.’s (TSE:TOU) P/E ratio could help you assess the value on offer. Tourmaline Oil has a P/E ratio of 14.27, based on the last twelve months. In other words, at today’s prices, investors are paying CA$14.27 for every CA$1 in prior year profit.
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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 Tourmaline Oil:
P/E of 14.27 = CA$18.86 ÷ CA$1.32 (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. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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.
Tourmaline Oil shrunk earnings per share by 5.2% last year. But it has grown its earnings per share by 6.0% per year over the last five years.
Does Tourmaline Oil Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Tourmaline Oil has a P/E ratio that is roughly in line with the oil and gas industry average (14.6).
Tourmaline Oil’s P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
So What Does Tourmaline Oil’s Balance Sheet Tell Us?
Tourmaline Oil’s net debt equates to 28% of its market capitalization. While that’s enough to warrant consideration, it doesn’t really concern us.
The Verdict On Tourmaline Oil’s P/E Ratio
Tourmaline Oil’s P/E is 14.3 which is about average (15) in the CA market. Given it has some debt, but didn’t grow last year, the P/E indicates the market is expecting higher profits ahead for the business.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Tourmaline Oil. 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.