Those holding Oil Search (ASX:OSH) shares must be pleased that the share price has rebounded 32% in the last thirty days. But unfortunately, the stock is still down by 48% over a quarter. However, that doesn't change the fact that longer term shareholders might have been mercilessly wrecked by the 56% share price decline throughout the year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). 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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Oil Search Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 10.68 that there is some investor optimism about Oil Search. As you can see below, Oil Search has a higher P/E than the average company (7.0) in the oil and gas industry.
That means that the market expects Oil Search will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. 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.
Oil Search shrunk earnings per share by 8.5% last year. But it has grown its earnings per share by 51% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 3.0% annually. So we might expect a relatively low P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
How Does Oil Search's Debt Impact Its P/E Ratio?
Oil Search's net debt is 66% of its market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Oil Search's P/E Ratio
Oil Search's P/E is 10.7 which is below average (14.9) in the AU market. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. What is very clear is that the market has become more optimistic about Oil Search over the last month, with the P/E ratio rising from 8.1 back then to 10.7 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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 Oil Search. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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. 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. Thank you for reading.