Unfortunately for some shareholders, the ConocoPhillips (NYSE:COP) share price has dived 58% in the last thirty days. Given the 64% drop over the last year, some shareholders might be worried that they have become bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.
Assuming nothing else has changed, a lower share price makes a stock more 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). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock 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 ConocoPhillips Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 3.82 that sentiment around ConocoPhillips isn't particularly high. We can see in the image below that the average P/E (6.4) for companies in the oil and gas industry is higher than ConocoPhillips's P/E.
ConocoPhillips's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
ConocoPhillips increased earnings per share by an impressive 20% over the last twelve months. And its annual EPS growth rate over 5 years is 6.8%. With that performance, you might expect an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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 ConocoPhillips's Debt Impact Its P/E Ratio?
Net debt totals 14% of ConocoPhillips's market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Bottom Line On ConocoPhillips's P/E Ratio
ConocoPhillips trades on a P/E ratio of 3.8, which is below the US market average of 11.5. The company hasn't stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. What can be absolutely certain is that the market has become more pessimistic about ConocoPhillips over the last month, with the P/E ratio falling from 9.1 back then to 3.8 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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