PrairieSky Royalty (TSE:PSK) shareholders are no doubt pleased to see that the share price has bounced 33% in the last month alone, although it is still down 36% over the last quarter. However, that doesn't change the fact that longer term shareholders might have been mercilessly wrecked by the 53% share price decline throughout the 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.
Does PrairieSky Royalty Have A Relatively High Or Low P/E For Its Industry?
PrairieSky Royalty's P/E of 22.64 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 lower than PrairieSky Royalty's P/E.
That means that the market expects PrairieSky Royalty will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. 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
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
PrairieSky Royalty increased earnings per share by 9.2% last year. And it has improved its earnings per share by 33% per year over the last three years. But earnings per share are down 23% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
How Does PrairieSky Royalty's Debt Impact Its P/E Ratio?
PrairieSky Royalty has net debt worth just 0.1% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On PrairieSky Royalty's P/E Ratio
PrairieSky Royalty's P/E is 22.6 which is above average (11.6) in its market. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future. What is very clear is that the market has become significantly more optimistic about PrairieSky Royalty over the last month, with the P/E ratio rising from 17.0 back then to 22.6 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.
Investors should be looking to buy stocks that the market is wrong about. 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 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 PrairieSky Royalty. 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 firstname.lastname@example.org. 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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