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Does North American Construction Group Ltd.'s (TSE:NOA) P/E Ratio Signal A Buying Opportunity?

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Simply Wall St
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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use North American Construction Group Ltd.'s (TSE:NOA) P/E ratio to inform your assessment of the investment opportunity. North American Construction Group has a P/E ratio of 13.97, based on the last twelve months. That means that at current prices, buyers pay CA$13.97 for every CA$1 in trailing yearly profits.

See our latest analysis for North American Construction Group

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for North American Construction Group:

P/E of 13.97 = CA$14.04 ÷ CA$1.00 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

How Does North American Construction Group's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (15.3) for companies in the energy services industry is higher than North American Construction Group's P/E.

TSX:NOA Price Estimation Relative to Market, October 21st 2019
TSX:NOA Price Estimation Relative to Market, October 21st 2019

This suggests that market participants think North American Construction Group will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

North American Construction Group's earnings made like a rocket, taking off 96% last year.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. 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.

Is Debt Impacting North American Construction Group's P/E?

North American Construction Group's net debt is 81% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Bottom Line On North American Construction Group's P/E Ratio

North American Construction Group trades on a P/E ratio of 14.0, which is fairly close to the CA market average of 13.7. It does have enough debt to add risk, although earnings growth was strong in the last year. The P/E suggests that the market is not convinced EPS will continue to improve strongly.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: North American Construction Group 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).

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.

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. Thank you for reading.