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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Encana Corporation's (TSE:ECA) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Encana has a P/E ratio of 9.89. That is equivalent to an earnings yield of about 10%.
Check out our latest analysis for Encana
How Do You Calculate Encana's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Encana:
P/E of 9.89 = $6.51 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.66 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Most would be impressed by Encana earnings growth of 17% in the last year. In contrast, EPS has decreased by 9.1%, annually, over 5 years.
Does Encana Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see Encana has a lower P/E than the average (16) in the oil and gas industry classification.
Encana's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.