This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Earthstone Energy, Inc.'s (NYSE:ESTE) P/E ratio and reflect on what it tells us about the company's share price. What is Earthstone Energy's P/E ratio? Well, based on the last twelve months it is 4.13. That means that at current prices, buyers pay $4.13 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Earthstone Energy:
P/E of 4.13 = $4.03 ÷ $0.98 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company 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 Earthstone Energy Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Earthstone Energy has a lower P/E than the average (10.3) P/E for companies in the oil and gas industry.
Its relatively low P/E ratio indicates that Earthstone Energy shareholders think it will struggle to do as well as other companies in its industry classification. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. 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.
Earthstone Energy's 160% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Earthstone Energy's Balance Sheet
Earthstone Energy's net debt equates to 40% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Earthstone Energy's P/E Ratio
Earthstone Energy's P/E is 4.1 which is below average (17.8) in the US market. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
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 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.
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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.