Devon Energy Corporation's (NYSE:DVN) price-to-earnings (or "P/E") ratio of 8.8x might make it look like a buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 17x and even P/E's above 32x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.
Devon Energy has been struggling lately as its earnings have declined faster than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.
Is There Any Growth For Devon Energy?
There's an inherent assumption that a company should underperform the market for P/E ratios like Devon Energy's to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 36%. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 1.4% each year over the next three years. That's not great when the rest of the market is expected to grow by 10% per annum.
In light of this, it's understandable that Devon Energy's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
What We Can Learn From Devon Energy's P/E?
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
As we suspected, our examination of Devon Energy's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.
Before you settle on your opinion, we've discovered 3 warning signs for Devon Energy (1 makes us a bit uncomfortable!) that you should be aware of.
Of course, you might also be able to find a better stock than Devon Energy. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.