The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Oracle Energy Corp (CVE:OEC)’s fundamentals and stock market performance.
Oracle Energy Corp (CVE:OEC) is currently trading at a trailing P/E of 30.1x, which is higher than the industry average of 20.7x. While this makes OEC appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Oracle Energy
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for OEC
Price per share = CA$0.30
Earnings per share = CA$0.00996
∴ Price-Earnings Ratio = CA$0.30 ÷ CA$0.00996 = 30.1x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to OEC, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
Since OEC’s P/E of 30.1x is higher than its industry peers (20.7x), it means that investors are paying more than they should for each dollar of OEC’s earnings. As such, our analysis shows that OEC represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that OEC should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to OEC. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared riskier firms with OEC, then investors would naturally value OEC at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with OEC, investors would also value OEC at a higher price since it is a higher growth investment. Both scenarios would explain why OEC has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing OEC to are fairly valued by the market. If this assumption is violated, OEC’s P/E may be higher than its peers because its peers are actually undervalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to OEC. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
- Financial Health: Is OEC’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has OEC been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of OEC’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.