This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Concho Resources Inc.’s (NYSE:CXO) P/E ratio to inform your assessment of the investment opportunity. Concho Resources has a P/E ratio of 18.49, based on the last twelve months. That is equivalent to an earnings yield of about 5.4%.
View our latest analysis for Concho Resources
How Do I Calculate Concho Resources’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Concho Resources:
P/E of 18.49 = $120.67 ÷ $6.53 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Concho Resources increased earnings per share by a whopping 71% last year. And it has bolstered its earnings per share by 7.0% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Concho Resources’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Concho Resources has a higher P/E than the average (12) P/E for companies in the oil and gas industry.
Its relatively high P/E ratio indicates that Concho Resources shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
Concho Resources’s Balance Sheet
Concho Resources’s net debt is 17% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Concho Resources’s P/E Ratio
Concho Resources’s P/E is 18.5 which is above average (17) in the US market. Its debt levels do not imperil its balance sheet and it has already proven it can grow. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Concho Resources. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.