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A Rising Share Price Has Us Looking Closely At Kelt Exploration Ltd.'s (TSE:KEL) P/E Ratio

Simply Wall St

Kelt Exploration (TSE:KEL) shareholders are no doubt pleased to see that the share price has bounced 35% in the last month alone, although it is still down 70% over the last quarter. But that will do little to salve the savage burn caused by the 79% share price decline, over the last year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

Check out our latest analysis for Kelt Exploration

How Does Kelt Exploration's P/E Ratio Compare To Its Peers?

Kelt Exploration's P/E of 33.37 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (8.1) for companies in the oil and gas industry is a lot lower than Kelt Exploration's P/E.

TSX:KEL Price Estimation Relative to Market April 26th 2020

That means that the market expects Kelt Exploration will outperform other companies in its industry. 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

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Kelt Exploration shrunk earnings per share by 20% over the last year. And EPS is down 16% a year, over the last 5 years. This could justify a pessimistic P/E.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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).

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.

So What Does Kelt Exploration's Balance Sheet Tell Us?

Kelt Exploration has net debt worth a very significant 168% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On Kelt Exploration's P/E Ratio

Kelt Exploration trades on a P/E ratio of 33.4, which is above its market average of 11.6. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company. What we know for sure is that investors have become much more excited about Kelt Exploration recently, since they have pushed its P/E ratio from 24.7 to 33.4 over the last month. 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.

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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Kelt Exploration. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.