To the annoyance of some shareholders, Entergy (NYSE:ETR) shares are down a considerable 31% in the last month. Even longer term holders have taken a real hit with the stock declining 6.6% in the last year.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
View our latest analysis for Entergy
Does Entergy Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 13.87 that sentiment around Entergy isn't particularly high. If you look at the image below, you can see Entergy has a lower P/E than the average (18.9) in the electric utilities industry classification.
Entergy's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's nice to see that Entergy grew EPS by a stonking 36% in the last year. And its annual EPS growth rate over 5 years is 3.9%. So we'd generally expect it to have a relatively high P/E ratio.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting Entergy's P/E?
Net debt totals a substantial 110% of Entergy's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On Entergy's P/E Ratio
Entergy has a P/E of 13.9. That's higher than the average in its market, which is 12.5. While its debt levels are rather high, at least its EPS is growing quickly. So despite the debt it is, perhaps, not unreasonable to see a high P/E ratio. What can be absolutely certain is that the market has become significantly less optimistic about Entergy over the last month, with the P/E ratio falling from 20.2 back then to 13.9 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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 modest (or no) debt, trading on a P/E below 20.
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.
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