A Sliding Share Price Has Us Looking At Confidence Petroleum India Limited's (NSE:CONFIPET) P/E Ratio

To the annoyance of some shareholders, Confidence Petroleum India (NSE:CONFIPET) shares are down a considerable 38% in the last month. Zooming out, the recent drop wiped out a year's worth of gains, with the share price now back where it was a year ago.

All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

Check out our latest analysis for Confidence Petroleum India

How Does Confidence Petroleum India's P/E Ratio Compare To Its Peers?

Confidence Petroleum India's P/E of 6.40 indicates relatively low sentiment towards the stock. The image below shows that Confidence Petroleum India has a lower P/E than the average (10.1) P/E for companies in the machinery industry.

Confidence Petroleum India's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Confidence Petroleum India saw earnings per share improve by 5.6% last year. And its annual EPS growth rate over 5 years is 142%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.

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 Confidence Petroleum India's Balance Sheet Tell Us?

Confidence Petroleum India has net debt worth just 0.9% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On Confidence Petroleum India's P/E Ratio

Confidence Petroleum India's P/E is 6.4 which is below average (9.2) in the IN market. EPS grew over the last twelve months, and debt levels are quite reasonable. If you believe growth will continue - or even increase - then the low P/E may signify opportunity. Given Confidence Petroleum India's P/E ratio has declined from 10.4 to 6.4 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.

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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.