When Should You Buy Frontera Energy Corporation (TSX:FEC)?
Frontera Energy Corporation (TSX:FEC) is currently trading at a trailing P/E of 0.5x, which is lower than the industry average of 22x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Frontera Energy
Demystifying the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for FEC
Price-Earnings Ratio = Price per share ÷ Earnings per share
FEC Price-Earnings Ratio = 40.56 ÷ 68.494 = 0.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to FEC, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. FEC’s P/E of 0.5x is lower than its industry peers (22x), which implies that each dollar of FEC’s earnings is being undervalued by investors. Therefore, according to this analysis, FEC is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy FEC, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to FEC, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with FEC, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing FEC to are fairly valued by the market. If this does not hold, there is a possibility that FEC’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to FEC. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If you are considering investing in FEC, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Frontera Energy for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass 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.
