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Why Gulf Keystone Petroleum Limited's (LON:GKP) High P/E Ratio Isn't Necessarily A Bad Thing

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Gulf Keystone Petroleum Limited's (LON:GKP) P/E ratio could help you assess the value on offer. Gulf Keystone Petroleum has a price to earnings ratio of 9.38, based on the last twelve months. That means that at current prices, buyers pay £9.38 for every £1 in trailing yearly profits.

View our latest analysis for Gulf Keystone Petroleum

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Gulf Keystone Petroleum:

P/E of 9.38 = $3.27 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.35 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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.

It's nice to see that Gulf Keystone Petroleum grew EPS by a stonking 466% in the last year. And its annual EPS growth rate over 5 years is 37%. With that performance, I would expect it to have an above average P/E ratio.

How Does Gulf Keystone Petroleum's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below Gulf Keystone Petroleum has a P/E ratio that is fairly close for the average for the oil and gas industry, which is 9.

LSE:GKP Price Estimation Relative to Market, March 30th 2019
LSE:GKP Price Estimation Relative to Market, March 30th 2019

That indicates that the market expects Gulf Keystone Petroleum will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.

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. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does Gulf Keystone Petroleum's Debt Impact Its P/E Ratio?

Gulf Keystone Petroleum has net cash of US$198m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Gulf Keystone Petroleum's P/E Ratio

Gulf Keystone Petroleum's P/E is 9.4 which is below average (15.5) in the GB market. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio. Given analysts are expecting further growth, one I would have expected a higher P/E ratio. So this stock may well be worth further research.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Gulf Keystone Petroleum may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.