Yahoo Finance Should You Be Tempted To Sell Encana Corporation (TSE:ECA) Because Of Its PE Ratio?
Encana Corporation (TSX:ECA) trades with a trailing P/E of 21.6x, which is higher than the industry average of 19.4x. While ECA 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Encana
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 ECA
Price-Earnings Ratio = Price per share ÷ Earnings per share
ECA Price-Earnings Ratio = $12.16 ÷ $0.562 = 21.6x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to ECA, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 21.6x, ECA’s P/E is higher than its industry peers (19.4x). This implies that investors are overvaluing each dollar of ECA’s earnings. Therefore, according to this analysis, ECA is an over-priced stock.
A few caveats
Before you jump to the conclusion that ECA should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to ECA, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with ECA, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing ECA to are fairly valued by the market. If this does not hold true, ECA’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on ECA, 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 highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for ECA’s future growth? Take a look at our free research report of analyst consensus for ECA’s outlook.
Past Track Record: Has ECA 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 ECA’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.
