Risks To Shareholder Returns Are Elevated At These Prices For Hydro One Limited (TSE:H)

Hydro One Limited's (TSE:H) price-to-earnings (or "P/E") ratio of 24.5x might make it look like a strong sell right now compared to the market in Canada, where around half of the companies have P/E ratios below 14x and even P/E's below 7x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, Hydro One has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Hydro One

Keen to find out how analysts think Hydro One's future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For Hydro One?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Hydro One's to be considered reasonable.

Retrospectively, the last year delivered a decent 6.5% gain to the company's bottom line. EPS has also lifted 20% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 6.3% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 12% per annum, 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. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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.

What We Can Learn From Hydro One's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

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. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you settle on your opinion, we've discovered 2 warning signs for Hydro One (1 makes us a bit uncomfortable!) that you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.