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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how NextEra Energy, Inc.’s (NYSE:NEE) P/E ratio could help you assess the value on offer. Based on the last twelve months, NextEra Energy’s P/E ratio is 12.8. That corresponds to an earnings yield of approximately 7.8%.
How Do I Calculate NextEra Energy’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for NextEra Energy:
P/E of 12.8 = $178.1 ÷ $13.92 (Based on the year 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. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Most would be impressed by NextEra Energy earnings growth of 21% in the last year. And its annual EPS growth rate over 5 years is 29%. With that performance, you might expect an above average P/E ratio.
How Does NextEra Energy’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that NextEra Energy has a lower P/E than the average (20.8) P/E for companies in the electric utilities industry.
NextEra Energy’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 NextEra Energy, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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.
NextEra Energy’s Balance Sheet
NextEra Energy has net debt worth 44% of its market capitalization. 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 NextEra Energy’s P/E Ratio
NextEra Energy has a P/E of 12.8. That’s below the average in the US market, which is 16.8. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than NextEra Energy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 firstname.lastname@example.org.