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Is Lundin Petroleum AB (publ)'s (STO:LUPE) 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 apply a basic P/E ratio analysis to Lundin Petroleum AB (publ)'s (STO:LUPE), to help you decide if the stock is worth further research. Lundin Petroleum has a P/E ratio of 17.15, based on the last twelve months. That corresponds to an earnings yield of approximately 5.8%.

See our latest analysis for Lundin Petroleum

How Do I Calculate Lundin Petroleum's Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Lundin Petroleum:

P/E of 17.15 = SEK29.55 (Note: this is the share price in the reporting currency, namely, USD ) ÷ SEK1.72 (Based on the year to September 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each SEK1 the company has earned over the last year. 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 Lundin Petroleum Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Lundin Petroleum has a higher P/E than the average (10.3) P/E for companies in the oil and gas industry.

OM:LUPE Price Estimation Relative to Market, December 4th 2019

Lundin Petroleum'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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Lundin Petroleum's 114% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The sweetener is that the annual five year growth rate of 75% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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.

Lundin Petroleum's Balance Sheet

Net debt is 46% of Lundin Petroleum's market cap. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Lundin Petroleum's P/E Ratio

Lundin Petroleum trades on a P/E ratio of 17.1, which is fairly close to the SE market average of 18.3. Given it has reasonable debt levels, and grew earnings strongly last year, the P/E indicates the market has doubts this growth can be sustained. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.

Investors should be looking to buy stocks that the market is wrong about. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Lundin Petroleum may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.