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 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.
Many companies are solely dedicated to the exploration and production of oil; however, several 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 specific ratios to fully understand a company's financial position and its long-term prospects. One of the more important financial ratios to consider is the price-to-earnings ratio (P/E ratio).
- The oil and gas drilling sector can provide profitable investments, but since the sector is volatile, investors should be aware of certain ratios beforehand.
- One of the ratios to consider is the price-to-earning (P/E) ratio, which provides insight into a company's or industry's value.
- 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 (affecting the P/E ratio), the significant amount of capital expenditures required in this sector becomes volatile, which is reflected in earnings.
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. It is also analyzed to determine the relative value of a company's shares to its peers in the industry or 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 using expected estimates for the upcoming four quarters. Whether for current or future calculations, a high P/E ratio typically means that shareholders will expect higher earnings growth than companies with lower P/E ratios.
There is no guarantee of increased returns even when a company has higher ratios than companies within the same sector or industry.
Oil and Gas Drilling P/E Ratio
As of January 2022, the average P/E ratio of the oil and gas drilling sector (oil and gas production and exploration) is 34.66.
The current S&P 500 10-year P/E Ratio is 11.78, which puts the oil and gas drilling P/E ratio above the P/E of the index. 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. Therefore, when oil prices are low, companies cut back on capital expenditures; when oil prices are high, they invest in capital expenditures.
The price-to-earnings ratio is a backward looking ratio that views past performance, which is another reason why it may not be the best ratio for predicting the returns of a volatile industry.
Because oil prices fluctuate greatly, capital expenditures become volatile throughout the industry. Earnings mirror the volatility, which makes the P/E ratio an unreliable indicator for the sector.
Also, many oil and gas drilling companies reinvest their cash flows into new assets, which can throw off the valuation as an accurate assessment of a company's actual profitability. Still, the P/E ratio can provide insight when comparing similar companies.
What Is a Good P/E Ratio by Industry?
A good P/E ratio depends on the industry and company. A company with a P/E of 10 may outperform a company with a P/E of 20. Similar companies in the same industry with the same business models and financial structures should have close to the same P/E. If one is higher, it generally indicates better returns, but not always.
What Is the P/E of the Energy Sector?
According to Finviz, the energy sector has a P/E of 8.48.
What Is the Average P/E Today?
Price-to-earnings varies by company, industry, sector, and is influenced by many factors. Therefore, the best way to find an overall P/E is to look at the P/E of an index, such as the S&P 500, Russell 2000, the MCSI indexes, or indexes that measure the industries you're interested in.
The Bottom Line
The oil and gas drilling category of the energy sector can yield good returns for investors seeking investment opportunities. However, the industry is volatile, so investors should be aware of all the relevant metrics, including the P/E ratio, before investing.