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To the annoyance of some shareholders, Texas Pacific Land Trust (NYSE:TPL) shares are down a considerable 42% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 35% drop over twelve months.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Texas Pacific Land Trust Have A Relatively High Or Low P/E For Its Industry?
Texas Pacific Land Trust's P/E of 11.37 indicates some degree of optimism towards the stock. The image below shows that Texas Pacific Land Trust has a higher P/E than the average (7.5) P/E for companies in the oil and gas industry.
Texas Pacific Land Trust's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Texas Pacific Land Trust's 53% 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 58% per year. With that kind of growth rate we would generally expect a high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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.
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 Texas Pacific Land Trust's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Texas Pacific Land Trust's US$304m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Texas Pacific Land Trust's P/E Ratio
Texas Pacific Land Trust trades on a P/E ratio of 11.4, which is below the US market average of 15.1. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic. Given Texas Pacific Land Trust's P/E ratio has declined from 19.5 to 11.4 in the last month, we know for sure that the market is significantly less confident 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 a contrarian, it may signal opportunity.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Texas Pacific Land Trust. 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 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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