This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Public Joint Stock Company RussNeft's (MCX:RNFT) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, RussNeft has a P/E ratio of 7.49. In other words, at today's prices, investors are paying RUB7.49 for every RUB1 in prior year profit.
How Do You Calculate RussNeft's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for RussNeft:
P/E of 7.49 = RUB560.00 ÷ RUB74.74 (Based on the year to June 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. 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.
How Does RussNeft's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, RussNeft has a higher P/E than the average company (5.3) in the oil and gas industry.
Its relatively high P/E ratio indicates that RussNeft shareholders think it will perform better than other companies in its industry classification. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, RussNeft grew EPS like Taylor Swift grew her fan base back in 2010; the 401% gain was both fast and well deserved. Regrettably, the longer term performance is poor, with EPS down 72% per year over 5 years.
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. 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.
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.
Is Debt Impacting RussNeft's P/E?
RussNeft has net debt worth 51% of its market capitalization. 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 Verdict On RussNeft's P/E Ratio
RussNeft's P/E is 7.5 which is about average (7.4) in the RU market. It does have enough debt to add risk, although earnings growth was strong in the last year. However, the P/E ratio implies that most doubt the strong growth will continue.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than RussNeft. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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