To the annoyance of some shareholders, Peyto Exploration & Development (TSE:PEY) shares are down a considerable 31% in the last month. And that drop will have no doubt have some shareholders concerned that the 78% share price decline, over the last year, has turned them into bagholders. What is a bagholder? It is a shareholder who has suffered a bad loss, but continues to hold indefinitely, without questioning their reasons for holding, even as the losses grow greater.

All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). 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 ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

Check out our latest analysis for Peyto Exploration & Development

Does Peyto Exploration & Development Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 2.52 that sentiment around Peyto Exploration & Development isn't particularly high. If you look at the image below, you can see Peyto Exploration & Development has a lower P/E than the average (8.3) in the oil and gas industry classification.

Its relatively low P/E ratio indicates that Peyto Exploration & Development shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Peyto Exploration & Development, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Peyto Exploration & Development maintained roughly steady earnings over the last twelve months. But it has grown its earnings per share by 8.7% per year over the last three years. And it has shrunk its earnings per share by 3.7% per year over the last five years. So you wouldn't expect a very high P/E.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Peyto Exploration & Development's Balance Sheet

Peyto Exploration & Development has net debt worth a very significant 261% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Bottom Line On Peyto Exploration & Development's P/E Ratio

Peyto Exploration & Development trades on a P/E ratio of 2.5, which is below the CA market average of 13.6. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations. What can be absolutely certain is that the market has become more pessimistic about Peyto Exploration & Development over the last month, with the P/E ratio falling from 3.7 back then to 2.5 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.

Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Peyto Exploration & Development may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 editorial-team@simplywallst.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. Thank you for reading.