This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Seplat Petroleum Development Company Plc’s (LON:SEPL) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Seplat Petroleum Development has a P/E ratio of 5.83. That corresponds to an earnings yield of approximately 17%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Seplat Petroleum Development:
P/E of 5.83 = $1.64 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.28 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings 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. When earnings grow, the ‘E’ increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Seplat Petroleum Development saw earnings per share decrease by 47% last year. But it has grown its earnings per share by 84% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 25% annually. This growth rate might warrant a below average P/E ratio.
How Does Seplat Petroleum Development’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Seplat Petroleum Development has a lower P/E than the average (9.4) P/E for companies in the oil and gas industry.
Its relatively low P/E ratio indicates that Seplat Petroleum Development shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Seplat Petroleum Development, 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
Don’t forget that the P/E ratio considers market capitalization. So it won’t reflect the advantage of cash, or disadvantage of debt. 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).
Seplat Petroleum Development’s Balance Sheet
Seplat Petroleum Development has net cash of US$304m. This is fairly high at 33% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Seplat Petroleum Development’s P/E Ratio
Seplat Petroleum Development’s P/E is 5.8 which is below average (16.4) in the GB market. The recent drop in earnings per share would make investors cautious, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
Investors should be looking to buy stocks that the market is wrong about. 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.
You might be able to find a better buy than Seplat Petroleum Development. 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 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.