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Odfjell Drilling (OB:ODL) shareholders are no doubt pleased to see that the share price has had a great month, posting a 36% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 18% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less 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. The implication here is that deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock 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.
See our latest analysis for Odfjell Drilling
How Does Odfjell Drilling's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 26.35 that there is some investor optimism about Odfjell Drilling. You can see in the image below that the average P/E (17.3) for companies in the energy services industry is lower than Odfjell Drilling's P/E.
Odfjell Drilling'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 delve deeper. I like to check if company insiders have been buying or selling.
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. 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.
Odfjell Drilling's earnings per share fell by 20% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 24% annually. This could justify a pessimistic P/E.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.