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What Is Earthstone Energy's (NYSE:ESTE) P/E Ratio After Its Share Price Rocketed?

Simply Wall St

It's great to see Earthstone Energy (NYSE:ESTE) shareholders have their patience rewarded with a 50% share price pop in the last month. But shareholders may not all be feeling jubilant, since the share price is still down 29% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

See our latest analysis for Earthstone Energy

Does Earthstone Energy Have A Relatively High Or Low P/E For Its Industry?

Earthstone Energy's P/E of 4.12 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Earthstone Energy has a lower P/E than the average (10.7) in the oil and gas industry classification.

NYSE:ESTE Price Estimation Relative to Market, November 11th 2019

This suggests that market participants think Earthstone Energy will underperform other companies in its industry. Since the market seems unimpressed with Earthstone Energy, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Earthstone Energy's earnings made like a rocket, taking off 344% last year.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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 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.

Is Debt Impacting Earthstone Energy's P/E?

Earthstone Energy's net debt equates to 32% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Earthstone Energy's P/E Ratio

Earthstone Energy's P/E is 4.1 which is below average (18.2) in the US market. The company hasn't stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. What is very clear is that the market has become less pessimistic about Earthstone Energy over the last month, with the P/E ratio rising from 2.8 back then to 4.1 today. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.

Investors should be looking to buy stocks that the market is wrong about. 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.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.