Why Elia System Operator SA’s (EBR:ELI) High P/E Ratio Isn’t Necessarily A Bad Thing

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how Elia System Operator SA’s (EBR:ELI) P/E ratio could help you assess the value on offer. What is Elia System Operator’s P/E ratio? Well, based on the last twelve months it is 15.38. In other words, at today’s prices, investors are paying €15.38 for every €1 in prior year profit.

View our latest analysis for Elia System Operator

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Elia System Operator:

P/E of 15.38 = €69.5 ÷ €4.52 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

How Does Elia System Operator’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Elia System Operator has a higher P/E than the average (12.6) P/E for companies in the electric utilities industry.

ENXTBR:ELI Price Estimation Relative to Market, July 26th 2019
ENXTBR:ELI Price Estimation Relative to Market, July 26th 2019

Elia System Operator’s P/E tells us that market participants think the company will perform better than its industry peers, going forward.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It’s nice to see that Elia System Operator grew EPS by a stonking 32% in the last year. And it has bolstered its earnings per share by 9.3% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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 Elia System Operator’s P/E?

Net debt totals 97% of Elia System Operator’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.

The Verdict On Elia System Operator’s P/E Ratio

Elia System Operator has a P/E of 15.4. That’s around the same as the average in the BE market, which is 15.1. It does have enough debt to add risk, although earnings growth was strong in the last year. The P/E suggests that the market is not convinced EPS will continue to improve strongly.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

But note: Elia System Operator 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).

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.

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. Thank you for reading.