Pinning Down Hydro One Limited's (TSE:H) P/E Is Difficult Right Now

With a price-to-earnings (or "P/E") ratio of 22x Hydro One Limited (TSE:H) may be sending very bearish signals at the moment, given that almost half of all companies in Canada have P/E ratios under 13x and even P/E's lower than 7x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Hydro One certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Growth For Hydro One?

Hydro One's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings growth, the company posted a worthy increase of 7.2%. Still, lamentably EPS has fallen 40% in aggregate from three years ago, which is disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 6.4% per annum during the coming three years according to the nine analysts following the company. Meanwhile, the rest of the market is forecast to expand by 9.6% each year, which is noticeably more attractive.

With this information, we find it concerning that Hydro One is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Hydro One currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Plus, you should also learn about these 2 warning signs we've spotted with Hydro One (including 1 which can't be ignored).

If you're unsure about the strength of Hydro One's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com