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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 Valero Energy Corporation's (NYSE:VLO) P/E ratio could help you assess the value on offer. Valero Energy has a P/E ratio of 12.1, based on the last twelve months. That means that at current prices, buyers pay $12.1 for every $1 in trailing yearly profits.
See our latest analysis for Valero Energy
How Do I Calculate Valero Energy's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Valero Energy:
P/E of 12.1 = $88.41 ÷ $7.31 (Based on the trailing twelve months to December 2018.)
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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Valero Energy saw earnings per share decrease by 20% last year. But over the longer term (5 years) earnings per share have increased by 7.9%. And over the longer term (3 years) earnings per share have decreased 3.1% annually. This might lead to low expectations.
Does Valero Energy 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. You can see in the image below that the average P/E (12.4) for companies in the oil and gas industry is roughly the same as Valero Energy's P/E.
Its P/E ratio suggests that Valero Energy shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.