The Average Price-to-Earnings Ratio in the Oil and Gas Drilling Sector

The energy sector provides unique opportunities for individuals interested in investing, especially with companies that operate under the oil and gas drilling category. The oil and gas drilling sector focuses on the companies that explore the world for the reservoirs of raw materials that can be refined into usable oil and then drill to extract that material. In the oil industry, this is known as the "upstream" part of the business.

There are many companies solely dedicated to the exploration and production of oil, however, many large companies are involved in all aspects of the oil industry. These companies are known as integrated oil companies, the "supermajors" or "big oil." Examples of big oil companies include Exxon, BP, and Shell.

To determine whether a company is appropriate to add as an asset class within an investor’s portfolio, it is necessary to calculate certain ratios, to fully understand the financial position of a company, as well as its long-term prospects. One of the more important financial ratios to consider is the price-to-earnings ratio (P/E ratio).

Key Takeaways

  • The oil and gas drilling sector can provide profitable investments, but since the sector is volatile, investors should be aware of certain rations beforehand.
  • One of the ratios to consider is the price-to-earning (P/E) ratio, which provides insight into the value of a company or industry.
  • The P/E ratio of a company or industry compares its current share price to its per-share earnings. However, many analysts argue that the P/E ratio is not the best-suited ratio for the oil and gas sector.
  • Because oil prices fluctuate greatly, the great amount of capital expenditures required in this sector becomes volatile, making earnings volatile, and so does the P/E ratio.

P/E Ratio

The P/E ratio of a company or specific industry gives insight into the value of that company or industry by comparing its current share price to its per-share earnings. The P/E ratio is calculated by dividing the market value of a company's shares by its earnings per share (EPS).

P/E Ratio = Market value per share / Earnings per share

The ratio is typically calculated using share price information from the previous four quarters and analyzed to determine the relative value of a company's shares to its peers in the industry or to a specific benchmark. The P/E ratio helps determine if a stock is overvalued or undervalued.

The P/E ratio can also be used as a projection tool by using expected estimates for the upcoming four quarters. Whether for current or future calculations, a high P/E ratio typically means that shareholders can expect growth on earnings that are higher than companies with lower P/E ratios, but only when compared to companies within the same sector or industry.

Oil and Gas Drilling P/E Ratio

As of January 2021, the average P/E ratio of the oil and gas drilling sector (oil and gas production and exploration) is 25.15.

The current S&P500 10-year P/E Ratio is 39.3. (above the modern-era market average of 19.6), which puts the oil and gas drilling P/E ratio below. However, many analysts argue that the P/E ratio is not the best-suited ratio for the oil and gas sector.

This view is taken mainly because the oil and gas drilling sector requires a lot of capital expenditure for the tremendous amount of machinery involved in the business. When oil prices are low, companies cut back on capital expenditures, when oil prices are high, they invest in capital expenditures.

Because oil prices fluctuate greatly, this makes capital expenditures volatile, which makes earnings volatile, and so makes the P/E ratio a difficult indicator for the sector. Also, many oil and gas drilling companies reinvest their cash flows into new assets, which can also throw off the valuation as a true assessment of a company's real profitability. Still, the P/E ratio can provide insight when comparing similar companies.

The Bottom Line

For investors seeking opportunities in investing, the energy sector can provide opportunities within oil and gas drilling companies. The sector is volatile, so investors should be aware of all relevant metrics, including the P/E ratio, before investing.

Article Sources
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  1. NYU Stern School of Business. "PE Ratio by Sector (US)." Accessed Nov. 25, 2021.

  2. Current Market Valuation. "Price/Earnings Ratio suggests that the US stock market is Strongly Overvalued." Accessed Nov. 25, 2021.
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