To the annoyance of some shareholders, Callon Petroleum (NYSE:CPE) shares are down a considerable 33% in the last month. Given the 62% drop over the last year, some shareholders might be worried that they have become bagholders. What is a bagholder? It is a shareholder who has suffered a bad loss, but continues to hold indefinitely, without questioning their reasons for holding, even as the losses grow greater.
All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Callon Petroleum Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 2.74 that sentiment around Callon Petroleum isn’t particularly high. If you look at the image below, you can see Callon Petroleum has a lower P/E than the average (8.7) in the oil and gas industry classification.
Its relatively low P/E ratio indicates that Callon Petroleum shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Callon Petroleum, it’s quite possible it could surprise on the upside. You should delve deeper.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
It’s nice to see that Callon Petroleum grew EPS by a stonking 35% in the last year. And it has bolstered its earnings per share by 24% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Callon Petroleum’s Debt Impact Its P/E Ratio?
Callon Petroleum has net debt worth a very significant 106% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Verdict On Callon Petroleum’s P/E Ratio
Callon Petroleum has a P/E of 2.7. That’s below the average in the US market, which is 18.4. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If it continues to grow, then the current low P/E may prove to be unjustified. What can be absolutely certain is that the market has become more pessimistic about Callon Petroleum over the last month, with the P/E ratio falling from 4.1 back then to 2.7 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.