I am writing today to help inform people who are new to the stock market and want to begin learning the link between Imperial Oil Limited (TSE:IMO)’s fundamentals and stock market performance.
Imperial Oil Limited (TSE:IMO) is trading with a trailing P/E of 53.8x, which is higher than the industry average of 20.2x. While this makes IMO appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Imperial Oil
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 IMO
Price-Earnings Ratio = Price per share ÷ Earnings per share
IMO Price-Earnings Ratio = CA$43.23 ÷ CA$0.803 = 53.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as IMO, 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. IMO’s P/E of 53.8x is higher than its industry peers (20.2x), which implies that each dollar of IMO’s earnings is being overvalued by investors. As such, our analysis shows that IMO represents an over-priced stock.
A few caveats
However, before you rush out to sell your IMO shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to IMO. 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 IMO, 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 IMO to are fairly valued by the market. If this does not hold, there is a possibility that IMO’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on IMO, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 IMO’s future growth? Take a look at our free research report of analyst consensus for IMO’s outlook.
- Past Track Record: Has IMO 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 IMO’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.