The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Enagás, S.A.’s (BME:ENG) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Enagás’s P/E ratio is 12.37. That corresponds to an earnings yield of approximately 8.1%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Enagás:
P/E of 12.37 = EUR22.76 ÷ EUR1.84 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.
Does Enagás Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (20.3) for companies in the gas utilities industry is higher than Enagás’s P/E.
Enagás’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Enagás, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Enagás’s earnings per share were pretty steady over the last year. But it has grown its earnings per share by 1.5% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Enagás’s Balance Sheet Tell Us?
Net debt totals 67% of Enagás’s 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 Verdict On Enagás’s P/E Ratio
Enagás has a P/E of 12.4. That’s below the average in the ES market, which is 17.0. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Enagás. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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