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Despite Its High P/E Ratio, Is Endesa, S.A. (BME:ELE) Still Undervalued?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Endesa, S.A.’s (BME:ELE) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Endesa’s P/E ratio is 16.36. That means that at current prices, buyers pay €16.36 for every €1 in trailing yearly profits.

How Do You Calculate Endesa’s P/E Ratio?

The formula for P/E is:

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

Or for Endesa:

P/E of 16.36 = €21.92 ÷ €1.34 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each €1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Endesa saw earnings per share decrease by 3.0% last year. But it has grown its earnings per share by 36% per year over the last five years.

How Does Endesa’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 Endesa has a higher P/E than the average (12.6) P/E for companies in the electric utilities industry.

Its relatively high P/E ratio indicates that Endesa shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don’t Consider The Balance Sheet

Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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).

How Does Endesa’s Debt Impact Its P/E Ratio?

Endesa has net debt worth just 5.3% of its market capitalization. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Endesa’s P/E Ratio

Endesa’s P/E is 16.4 which is below average (17.8) in the ES market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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.

Of course you might be able to find a better stock than Endesa. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.