Valero Energy Corporation's (NYSE:VLO) Prospects Need A Boost To Lift Shares

Valero Energy Corporation's (NYSE:VLO) price-to-earnings (or "P/E") ratio of 7.6x might make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 18x and even P/E's above 32x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

Valero Energy has been struggling lately as its earnings have declined faster than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

View our latest analysis for Valero Energy

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Valero Energy.

How Is Valero Energy's Growth Trending?

There's an inherent assumption that a company should far underperform the market for P/E ratios like Valero Energy's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 43%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Looking ahead now, EPS is anticipated to slump, contracting by 13% per annum during the coming three years according to the analysts following the company. Meanwhile, the broader market is forecast to expand by 10.0% each year, which paints a poor picture.

In light of this, it's understandable that Valero Energy's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Valero Energy's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 2 warning signs for Valero Energy you should be aware of, and 1 of them shouldn't be ignored.

If you're unsure about the strength of Valero Energy's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.