The energy sector offers unique opportunities for those interested in investing, especially with companies that operate in the oil and gas drilling category. The oil and gas drilling industry focuses on companies that explore the world for reservoirs of raw materials that can be refined into usable oil and then drill to extract that material. In the oil industry, this is called the “upstream“part of the business.
Many companies are dedicated solely to the exploration and production of oil; however, several large companies are involved in all aspects of the petroleum industry. These companies are known as integrated the oil companies, the “supermajors” or “big oil”. Examples of major oil companies include Exxon, BP and Shell.
To determine whether to add a company as an asset class within an investor’s portfolio, it is necessary to calculate specific ratios to fully understand a company’s financial condition and its long-term prospects. term. One of the most important financial ratios to consider is the price/earnings ratio (P/E ratio).
Key points to remember
- The oil and gas drilling sector can provide profitable investments, but since the sector is volatile, investors should know certain ratios beforehand.
- One of the ratios to consider is the price-to-earnings (P/E) ratio, which provides insight into the value of a company or sector.
- The P/E ratio of a company or industry compares its current stock price to its earnings per share. However, many analysts argue that the P/E ratio is not the ratio best suited for the oil and gas sector.
- Since oil prices fluctuate widely (affecting the P/E ratio), the large amount of capital expenditure required in this sector becomes volatile, which is reflected in earnings.
The P/E ratio of a specific company or sector provides insight into the value of that company or sector by comparing its current stock price to its earnings per share. The P/E ratio is calculated by dividing the market value of a company’s stock by its earnings per share (EPS).
P/E ratio = Market value per share / Earnings per share
The ratio is usually calculated using stock price information from the previous four quarters. It is also analyzed to determine the relative value of a company’s stock against its industry peers or a specific benchmark. The P/E ratio helps determine whether a stock is overvalued or undervalued.
The P/E ratio can also be used as a projection tool using expected estimates for the next four quarters. Whether for current or future calculations, a high P/E ratio generally means that shareholders expect higher earnings growth than companies with lower P/E ratios.
There is no guarantee of increased returns even when a company has higher ratios than companies in the same sector or industry.
P/E ratio of oil and gas drilling
In January 2022, the average P/E ratio of the oil and gas drilling sector (oil and gas production and exploration) is 34.66.
The current 10-year S&P 500 P/E ratio is 11.78, which puts the P/E ratio for oil and gas drilling above the P/E for the index. However, many analysts argue that the P/E ratio is not the ratio best suited for the oil and gas sector.
This point of view is adopted mainly because the oil and gas drilling sector requires a lot of capital expenditure for the huge amount of machinery involved in the business. Thus, when oil prices are low, companies reduce their investment expenditure; when oil prices are high, they invest in capital expenditure.
The price-to-earnings ratio is a backward-looking ratio that looks at past performance, which is another reason why it may not be the best ratio for predicting returns in a volatile industry.
Since oil prices fluctuate widely, capital expenditures become volatile throughout the industry. Earnings reflect volatility, which makes the P/E ratio an unreliable indicator for the sector.
Additionally, many oil and gas drilling companies reinvest their cash flow into new assets, which can skew the valuation as an accurate assessment of a company’s true profitability. Still, the P/E ratio can provide insight when comparing similar companies.
What is a good P/E ratio by industry?
A good P/E ratio depends on the industry and the company. A company with a P/E of 10 can outperform a company with a P/E of 20. Similar companies in the same industry with the same business models and financial structures should have a P/E close to the same. If one is higher, it usually indicates better yields, but not always.
What is the P/E of the energy sector?
According to Finviz, the energy sector has a P/E of 8.48.
What is the average P/E today?
The price/earnings ratio varies by company, industry, sector and is influenced by many factors. Therefore, the best way to find an overall P/E is to look at the P/E of an index, such as the S&P 500, Russell 2000, MCSI indices, or indices that measure the industries you are interested in.
The oil and gas drilling category of the energy sector can generate good returns for investors looking for investment opportunities. However, the industry is volatile, so investors should be aware of all the relevant metricsincluding the P/E ratio, before investing.
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