Is It Time To Sell Occidental Petroleum Corporation (NYSE:OXY) Based Off Its PE Ratio?
Occidental Petroleum Corporation (NYSE:OXY) is trading with a trailing P/E of 98.1x, which is higher than the industry average of 14.1x. While OXY might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Occidental Petroleum
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 OXY
Price-Earnings Ratio = Price per share ÷ Earnings per share
OXY Price-Earnings Ratio = $69.5 ÷ $0.709 = 98.1x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to OXY, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. OXY’s P/E of 98.1x is higher than its industry peers (14.1x), which implies that each dollar of OXY’s earnings is being overvalued by investors. Therefore, according to this analysis, OXY is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your OXY shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to OXY, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with OXY, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing OXY to are fairly valued by the market. If this does not hold true, OXY’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? 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 OXY. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in OXY, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Occidental Petroleum for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
