Ovintiv (TSE:OVV) shareholders are no doubt pleased to see that the share price has bounced 88% in the last month alone, although it is still down 54% over the last quarter. However, that doesn’t change the fact that longer term shareholders might have been mercilessly wrecked by the 77% share price decline throughout the year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So some would prefer to hold off buying when there is a lot of optimism towards a stock. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

See our latest analysis for Ovintiv

How Does Ovintiv’s P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 2.10 that sentiment around Ovintiv isn’t particularly high. If you look at the image below, you can see Ovintiv has a lower P/E than the average (9.4) in the oil and gas industry classification.

TSX:OVV Price Estimation Relative to Market May 20th 2020

Its relatively low P/E ratio indicates that Ovintiv shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Ovintiv, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Ovintiv increased earnings per share by 2.5% last year. But earnings per share are down 20% per year over the last five years.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

Is Debt Impacting Ovintiv’s P/E?

Net debt totals a substantial 373% of Ovintiv’s market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.

The Bottom Line On Ovintiv’s P/E Ratio

Ovintiv’s P/E is 2.1 which is below average (12.2) in the CA market. While the recent EPS growth is a positive, the significant amount of debt on the balance sheet may be contributing to pessimistic market expectations. What is very clear is that the market has become less pessimistic about Ovintiv over the last month, with the P/E ratio rising from 1.1 back then to 2.1 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you’re more sensitive to price, then you may feel the opportunity has passed.

Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Ovintiv. So you may wish to see this free collection of other companies that have grown earnings strongly.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.