This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Imperial Oil Limited's (TSE:IMO), to help you decide if the stock is worth further research. What is Imperial Oil's P/E ratio? Well, based on the last twelve months it is 8.34. That is equivalent to an earnings yield of about 12.0%.
How Do I Calculate Imperial Oil's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Imperial Oil:
P/E of 8.34 = CA$33.11 ÷ CA$3.97 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does Imperial Oil Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (8.6) for companies in the oil and gas industry is roughly the same as Imperial Oil's P/E.
Imperial Oil's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
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. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Imperial Oil's earnings made like a rocket, taking off 249% last year. And earnings per share have improved by 124% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio. Regrettably, the longer term performance is poor, with EPS down 2.8% per year over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Imperial Oil's Debt Impact Its P/E Ratio?
Imperial Oil's net debt is 14% of its market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Bottom Line On Imperial Oil's P/E Ratio
Imperial Oil has a P/E of 8.3. That's below the average in the CA market, which is 13.7. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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. Thank you for reading.