The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Continental Resources, Inc.'s (NYSE:CLR) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Continental Resources has a P/E ratio of 15.23. In other words, at today's prices, investors are paying $15.23 for every $1 in prior year profit.
How Do You Calculate Continental Resources's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Continental Resources:
P/E of 15.23 = $31.93 ÷ $2.10 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.
Does Continental Resources Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Continental Resources has a higher P/E than the average (10.7) P/E for companies in the oil and gas industry.
Continental Resources's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Continental Resources's earnings per share fell by 52% in the last twelve months. And EPS is down 4.9% a year, over the last 5 years. This might lead to muted expectations.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Continental Resources's Debt Impact Its P/E Ratio?
Net debt is 47% of Continental Resources's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Continental Resources's P/E Ratio
Continental Resources trades on a P/E ratio of 15.2, which is below the US market average of 18.3. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Continental Resources. So you may wish to see this free collection of other companies that have grown earnings strongly.
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If you spot an error that warrants correction, please contact the editor at email@example.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.