W&T Offshore (NYSE:WTI) shares have continued recent momentum with a 31% gain in the last month alone. The full year gain of 18% is pretty reasonable, too.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

See our latest analysis for W&T Offshore

W&T Offshore's P/E of 4.13 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (11.2) for companies in the oil and gas industry is higher than W&T Offshore's P/E.

NYSE:WTI Price Estimation Relative to Market, January 5th 2020

This suggests that market participants think W&T Offshore will underperform other companies in its industry. Since the market seems unimpressed with W&T Offshore, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

W&T Offshore's earnings made like a rocket, taking off 52% last year. The sweetener is that the annual five year growth rate of 61% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Net debt totals 83% of W&T Offshore's market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

W&T Offshore trades on a P/E ratio of 4.1, which is below the US market average of 18.8. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If it continues to grow, then the current low P/E may prove to be unjustified. What we know for sure is that investors are becoming less uncomfortable about W&T Offshore's prospects, since they have pushed its P/E ratio from 3.2 to 4.1 over the last month. For those who like to invest in turnarounds, that might mean it's time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.

Story continues

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 W&T Offshore. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.

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What Is W&T Offshore's (NYSE:WTI) P/E Ratio After Its Share Price Rocketed? - Yahoo Finance