Earthstone Energy (NYSE:ESTE) shares have continued recent momentum with a 32% gain in the last month alone. The full year gain of 30% is pretty reasonable, too.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So some would prefer to hold off buying when there is a lot of optimism towards a stock. Perhaps the simplest way to get a read on investors' expectations of a business 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.
How Does Earthstone Energy's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 4.61 that sentiment around Earthstone Energy isn't particularly high. If you look at the image below, you can see Earthstone Energy has a lower P/E than the average (10.8) in the oil and gas industry classification.
This suggests that market participants think Earthstone Energy 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. 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Earthstone Energy's 344% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Earthstone Energy's Balance Sheet
Earthstone Energy's net debt equates to 29% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Earthstone Energy's P/E Ratio
Earthstone Energy's P/E is 4.6 which is below average (18.9) in the US market. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. 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 3.5 back then to 4.6 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Earthstone Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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