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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Occidental Petroleum Corporation’s (NYSE:OXY) P/E ratio and reflect on what it tells us about the company’s share price. Occidental Petroleum has a P/E ratio of 12.14, based on the last twelve months. That means that at current prices, buyers pay $12.14 for every $1 in trailing yearly profits.
See our latest analysis for Occidental Petroleum
How Do You Calculate Occidental Petroleum’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Occidental Petroleum:
P/E of 12.14 = $65.85 ÷ $5.42 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s nice to see that Occidental Petroleum grew EPS by a stonking 218% in the last year. And it has bolstered its earnings per share by 3.1% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Occidental Petroleum’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (11.9) for companies in the oil and gas industry is roughly the same as Occidental Petroleum’s P/E.
Occidental Petroleum’s P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
How Does Occidental Petroleum’s Debt Impact Its P/E Ratio?
Net debt totals 15% of Occidental Petroleum’s market cap. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Bottom Line On Occidental Petroleum’s P/E Ratio
Occidental Petroleum trades on a P/E ratio of 12.1, which is below the US market average of 17. The company hasn’t stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors should be looking to buy stocks that the market is wrong about. 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.
But note: Occidental Petroleum may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.