This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at MDU Resources Group Inc’s (NYSE:MDU) P/E ratio and reflect on what it tells us about the company’s share price. MDU Resources Group has a P/E ratio of 16.78, based on the last twelve months. In other words, at today’s prices, investors are paying $16.78 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for MDU Resources Group:
P/E of 16.78 = $26.5 ÷ $1.58 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, MDU Resources Group grew EPS by a whopping 31% in the last year. And its annual EPS growth rate over 5 years is 10%. With that performance, I would expect it to have an above average P/E ratio.
How Does MDU Resources Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that MDU Resources Group has a P/E ratio that is roughly in line with the integrated utilities industry average (17.8).
That indicates that the market expects MDU Resources Group will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. I inform my view byby checking management tenure and remuneration, among other things.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
MDU Resources Group’s Balance Sheet
MDU Resources Group’s net debt is 35% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On MDU Resources Group’s P/E Ratio
MDU Resources Group trades on a P/E ratio of 16.8, which is fairly close to the US market average of 18. Given it has reasonable debt levels, and grew earnings strongly last year, the P/E indicates the market has doubts this growth can be sustained.
Investors have an opportunity when market expectations about a stock are wrong. 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 they key to an excellent investment decision.
But note: MDU Resources Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.