Energen Corporation (NYSE:EGN) is trading with a trailing P/E of 20.2x, which is higher than the industry average of 13.5x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Energen
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for EGN
Price-Earnings Ratio = Price per share ÷ Earnings per share
EGN Price-Earnings Ratio = $63.68 ÷ $3.157 = 20.2x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as EGN, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 20.2x, EGN’s P/E is higher than its industry peers (13.5x). This implies that investors are overvaluing each dollar of EGN’s earnings. As such, our analysis shows that EGN represents an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your EGN shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to EGN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with EGN, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing EGN to are fairly valued by the market. If this does not hold true, EGN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in EGN. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for EGN’s future growth? Take a look at our free research report of analyst consensus for EGN’s outlook.
- Past Track Record: Has EGN been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of EGN’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.