The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Fortis Inc's (TSE:FTS) P/E ratio could help you assess the value on offer. Fortis has a P/E ratio of 18.57, based on the last twelve months. In other words, at today's prices, investors are paying CA$18.57 for every CA$1 in prior year profit.
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Fortis:
P/E of 18.57 = CA$42.99 ÷ CA$2.31 (Based on the year to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Fortis's earnings per share were pretty steady over the last year. But over the longer term (5 years) earnings per share have increased by 9.2%.
How Does Fortis's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (20.8) for companies in the electric utilities industry is higher than Fortis's P/E.
TSX:FTS PE PEG Gauge October 30th 18
This suggests that market participants think Fortis will underperform other companies in its industry. Since the market seems unimpressed with Fortis, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Fortis's P/E?
Fortis's net debt is considerable, at 126% of its market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Verdict On Fortis's P/E Ratio
Fortis's P/E is 18.6 which is above average (14.7) in the CA market. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this freevisual report on analyst forecasts could hold they key to an excellent investment decision.
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 editorial-team@simplywallst.com.
Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.
About TSX:FTS
Fortis
Operates as an electric and gas utility company in Canada, the United States, and the Caribbean countries.
