Why Enbridge Inc.’s (TSE:ENB) High P/E Ratio Isn’t Necessarily A Bad Thing

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Enbridge Inc.’s (TSE:ENB) P/E ratio to inform your assessment of the investment opportunity. Enbridge has a price to earnings ratio of 33.18, based on the last twelve months. That is equivalent to an earnings yield of about 3.0%.

View our latest analysis for Enbridge

How Do I Calculate Enbridge’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for Enbridge:

P/E of 33.18 = CA$48.4 ÷ CA$1.46 (Based on the year to December 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 CA$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about 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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Enbridge’s earnings per share fell by 12% in the last twelve months. But it has grown its earnings per share by 17% per year over the last five years.

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

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Enbridge has a higher P/E than the average (14.8) P/E for companies in the oil and gas industry.

TSX:ENB Price Estimation Relative to Market, March 31st 2019
TSX:ENB Price Estimation Relative to Market, March 31st 2019

That means that the market expects Enbridge will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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).

Is Debt Impacting Enbridge’s P/E?

Enbridge’s net debt is 66% 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 Enbridge’s P/E Ratio

Enbridge trades on a P/E ratio of 33.2, which is above the CA market average of 14.6. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Enbridge. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.