To the annoyance of some shareholders, W&T Offshore (NYSE:WTI) shares are down a considerable 30% in the last month. Even longer term holders have taken a real hit with the stock declining 20% in the last year.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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 ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does W&T Offshore Have A Relatively High Or Low P/E For Its Industry?
W&T Offshore's P/E of 2.88 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (8.3) for companies in the oil and gas industry is higher than W&T Offshore's P/E.
This suggests that market participants think W&T Offshore will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
W&T Offshore's 52% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 61% per year. With that kind of growth rate we would generally expect a high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does W&T Offshore's Debt Impact Its P/E Ratio?
W&T Offshore's net debt is considerable, at 119% of its market cap. 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 W&T Offshore's P/E Ratio
W&T Offshore trades on a P/E ratio of 2.9, which is below the US market average of 18.2. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If it continues to grow, then the current low P/E may prove to be unjustified. Given W&T Offshore's P/E ratio has declined from 4.1 to 2.9 in the last month, we know for sure that the market is more worried about the business today, than it was back then. 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 should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than W&T Offshore. 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 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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