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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Yangarra Resources Ltd.’s (TSE:YGR) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Yangarra Resources’s P/E ratio is 7.24. That corresponds to an earnings yield of approximately 14%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Yangarra Resources:
P/E of 7.24 = CA$2.87 ÷ CA$0.40 (Based on the year to December 2018.)
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
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. 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.
Yangarra Resources’s earnings made like a rocket, taking off 64% last year. The sweetener is that the annual five year growth rate of 44% is also impressive. So I’d be surprised if the P/E ratio was not above average.
How Does Yangarra Resources’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (15) for companies in the oil and gas industry is higher than Yangarra Resources’s P/E.
Its relatively low P/E ratio indicates that Yangarra Resources shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. So it won’t reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting Yangarra Resources’s P/E?
Yangarra Resources’s net debt is 55% of its market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Bottom Line On Yangarra Resources’s P/E Ratio
Yangarra Resources’s P/E is 7.2 which is below average (14.4) in the CA market. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Yangarra 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 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.