Those holding InPlay Oil Corp. (TSE:IPO) shares would be relieved that the share price has rebounded 35% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. The last month tops off a massive increase of 237% in the last year.
Although its price has surged higher, InPlay Oil's price-to-earnings (or "P/E") ratio of 2.8x might still make it look like a strong buy right now compared to the market in Canada, where around half of the companies have P/E ratios above 11x and even P/E's above 26x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
Recent times have been advantageous for InPlay Oil as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on InPlay Oil.
Does Growth Match The Low P/E?
There's an inherent assumption that a company should far underperform the market for P/E ratios like InPlay Oil's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 111% gain to the company's bottom line. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Shifting to the future, estimates from the sole analyst covering the company suggest earnings growth is heading into negative territory, declining 18% over the next year. That's not great when the rest of the market is expected to grow by 13%.
With this information, we are not surprised that InPlay Oil is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
The Final Word
Even after such a strong price move, InPlay Oil's P/E still trails the rest of the market significantly. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
As we suspected, our examination of InPlay Oil's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with InPlay Oil (at least 2 which are concerning), and understanding them should be part of your investment process.
If these risks are making you reconsider your opinion on InPlay Oil, explore our interactive list of high quality stocks to get an idea of what else is out there.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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