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Is Falcon Minerals Corporation's (NASDAQ:FLMN) High P/E Ratio A Problem For Investors?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Falcon Minerals Corporation's (NASDAQ:FLMN) P/E ratio to inform your assessment of the investment opportunity. What is Falcon Minerals's P/E ratio? Well, based on the last twelve months it is 17.22. That corresponds to an earnings yield of approximately 5.8%.

See our latest analysis for Falcon Minerals

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Falcon Minerals:

P/E of 17.22 = $6.96 ÷ $0.40 (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.

How Does Falcon Minerals's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Falcon Minerals has a higher P/E than the average (11.2) P/E for companies in the oil and gas industry.

NasdaqCM:FLMN Price Estimation Relative to Market, January 5th 2020

Falcon Minerals's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. 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.

Falcon Minerals shrunk earnings per share by 58% over the last year.

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. 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).

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).

Is Debt Impacting Falcon Minerals's P/E?

Net debt totals just 5.9% of Falcon Minerals's market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Falcon Minerals's P/E Ratio

Falcon Minerals has a P/E of 17.2. That's below the average in the US market, which is 18.8. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

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.

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.

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. Thank you for reading.