Should We Worry About ARC Resources Ltd.'s (TSE:ARX) P/E Ratio?

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how ARC Resources Ltd.'s (TSE:ARX) P/E ratio could help you assess the value on offer. What is ARC Resources's P/E ratio? Well, based on the last twelve months it is 22.77. That corresponds to an earnings yield of approximately 4.4%.

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price Ã· Earnings per Share (EPS)

Or for ARC Resources:

P/E of 22.77 = CA\$6.72 Ã· CA\$0.30 (Based on the trailing twelve months to March 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

ARC Resources shrunk earnings per share by 65% over the last year. And over the longer term (5 years) earnings per share have decreased 16% annually. This might lead to muted expectations.

Does ARC Resources Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, ARC Resources has a higher P/E than the average company (13.3) in the oil and gas industry.

That means that the market expects ARC Resources will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does ARC Resources's Debt Impact Its P/E Ratio?

ARC Resources has net debt equal to 31% of its market cap. While it's worth keeping this in mind, it isn't a worry.

The Verdict On ARC Resources's P/E Ratio

ARC Resources has a P/E of 22.8. That's higher than the average in the CA market, which is 15. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

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 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.