The price-to-earnings (P/E) ratio tells us how much an investor is willing to pay for every dollar of earnings generated by the company. The price will always be the same but the earnings used could reflect past or projected earnings. With future P/E the market's expectation of earnings are used and therefore could be flawed. Regardless, it is a widely used valuation that has also demonstrated a significant relationship with long-term stock returns. Despite its simplicity, it is a great starting point for starting stock analysis. (To learn more, check out our P/E Ratio Tutorial.)

P/E ratios, also known as multiples, should be compared to similar companies in similar industries. Typically utilities companies will have lower p/e ratios because of their slow and steady growth. It wouldn't make sense to compare them to technology companies, which tend to have an quickly changing industry and higher growth rates.

Here are some companies that have a low trailing 12 month P/E and are all in the oil and energy industry. Let's also take a peek at the price/earnings to growth (PEG) to get a feeling for the earnings growth expectations.

Company Trailing P/E PEG Market Cap
Berry Petroleum
(NYSE:BRY)
1.9 0.29 290M
Petro-Canada
(NYSE:PCZ)
2.5 0.26 9.96B
Mariner Energy
(NYSE:ME)
2.5 0.22 770M
Forest Oil
(NYSE:FST)
3.36 0.19 1.45B
St. Mary Land & Exploreer
(NYSE:SM)
4.09 0.42 1.17B

Petro-Canada
Petro-Canada (also TSX:PCA) is one of Canada's largest oil and gas companies, which engages in both upstream and downstream operations in the energy sector. On December 11 it reaffirmed previous production outlooks for the full 2008 year to be in the range of 400,000 to 420,000 barrels of oil equivalent per day (boe/d). More specifically, they reaffirmed the high end of the range.

2009 is expected to have production between 360,000 and 395,000 boe/d, but is expected to see a tightening of the budget to accommodate a low price in oil. Petro-Canada's board cut the exploration budget 36%, down to CDN$4 billion from 2008's $6.2 billion. In upstream segments the main way to increase earnings is to find new reserves, so a cut of the exploration budget to pre-2008 levels is not a good sign. According to CEO Ron Brenneman, this is not set in stone, so if the commodity and financial markets start moving in Petro-Canada's favor it will adjust the budget. With a P/E and PEG both at about 1/3 what the industry average is, it could be undervalued. (Read more in our Oil And Gas Industry Primer.)

Capital Spending Cuts But Increases Production
Berry Petroleum is also cutting its capital spending for 2009 stating in early December that it will cut the budget by 75% to $100 million. Production is expected to increase by 3% to 33,500 boe/d. Mariner Energy also cut its capital spending by 70% to $431 million and expects a 20% increase in production. Berry does have a P/E below 2 in the last 12 months, which is lower than Mariner Energy and about the same PEG - well below the industry average. Both have a flexible budget in place in the event oil prices move back up. Berry Petroleum CEO Robert Heinemann explained, "we have a number of opportunities in our portfolio and we would quickly implement a $200 million capital budget."

Conclusion

Buying a stock when its P/E is depressed can provide big payoffs to patient investors. The important thing to do is determine if the characteristics of the company are comparable to its peers and industry. The P/E is often lower because the stock simply does not have the same earnings potential. However, there are many cases where the market sours on a stock in the short term and drives down its P/E. Finding those undervalued gems can help boost portfolio returns.

To learn more on this and other strategies, read our Guide To Stock Picking Strategies.

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