Is The AES Corporation's (NYSE:AES) PE Ratio A Signal To Sell For Investors?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today's market.

The AES Corporation (NYSE:AES) trades with a trailing P/E of 36.9, which is higher than the industry average of 17.1. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will break down what the P/E ratio is, how to interpret it and what other factors to keep in mind.

View our latest analysis for AES

Breaking down the Price-Earnings ratio

The P/E ratio is one of many ratios used in relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AES, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.

At 36.9, AES’s P/E is higher than its industry peers (17.1). This implies that investors are overvaluing each dollar of AES’s earnings. This multiple is a median of profitable companies of 25 Renewable Energy companies in US including Kenon Holdings, CGE Energy and Central Puerto. You could also say that the market is suggesting that AES has a stronger business than the average comparable company.

A few caveats

However, it is important to note that our examination of the stock is based on certain assumptions. Firstly, that our peer group contains companies that are similar to AES. If this isn’t the case, the difference in P/E could be due to other factors. For example, The AES Corporation could be growing more quickly than the companies we're comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with AES are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.

What this means for you:

If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in AES. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:

1. Future Outlook: What are well-informed industry analysts predicting for AES’s future growth? Take a look at our free research report of analyst consensus for AES’s outlook.
2. Past Track Record: Has AES been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of AES's historicals for more clarity.
3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

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.