Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at CVR Energy, Inc.'s (NYSE:CVI) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, CVR Energy has a P/E ratio of 15.67. In other words, at today's prices, investors are paying $15.67 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for CVR Energy:
P/E of 15.67 = $53.92 ÷ $3.44 (Based on the trailing twelve months to March 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.'
Does CVR Energy Have A Relatively High Or Low P/E For Its Industry?
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 (12.9) for companies in the oil and gas industry is lower than CVR Energy's P/E.
CVR Energy's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
CVR Energy increased earnings per share by 9.5% last year. And it has improved its earnings per share by 45% per year over the last three years. Unfortunately, earnings per share are down 2.1% a year, over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
CVR Energy's Balance Sheet
CVR Energy's net debt is 13% of its 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 Verdict On CVR Energy's P/E Ratio
CVR Energy has a P/E of 15.7. That's below the average in the US market, which is 18. EPS grew over the last twelve months, and debt levels are quite reasonable. If you believe growth will continue - or even increase - then the low P/E may signify opportunity.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than CVR Energy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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.