To the annoyance of some shareholders, Valero Energy (NYSE:VLO) shares are down a considerable 35% in the last month. That drop has capped off a tough year for shareholders, with the share price down 36% in that time.
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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Valero Energy's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 9.31 that there is some investor optimism about Valero Energy. You can see in the image below that the average P/E (8.1) for companies in the oil and gas industry is lower than Valero Energy's P/E.
Valero Energy'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 always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Valero Energy shrunk earnings per share by 20% over the last year. But over the longer term (3 years), earnings per share have increased by 5.7%. And EPS is down 3.6% a year, over the last 5 years. This could justify a pessimistic P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 Valero Energy's Debt Impact Its P/E Ratio?
Net debt is 28% of Valero Energy's market cap. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On Valero Energy's P/E Ratio
Valero Energy's P/E is 9.3 which is below average (14.7) in the US market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment. What can be absolutely certain is that the market has become more pessimistic about Valero Energy over the last month, with the P/E ratio falling from 14.4 back then to 9.3 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors should be looking to buy stocks that the market is wrong about. 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 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 Valero Energy. 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 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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