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Is American Electric Power Company, Inc.'s (NYSE:AEP) P/E Ratio Really That Good?

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at American Electric Power Company, Inc.'s (NYSE:AEP) P/E ratio and reflect on what it tells us about the company's share price. What is American Electric Power Company's P/E ratio? Well, based on the last twelve months it is 22.15. That means that at current prices, buyers pay $22.15 for every $1 in trailing yearly profits.

Check out our latest analysis for American Electric Power Company

How Do I Calculate American Electric Power Company's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for American Electric Power Company:

P/E of 22.15 = $91.76 ÷ $4.14 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does American Electric Power Company Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. As you can see below American Electric Power Company has a P/E ratio that is fairly close for the average for the electric utilities industry, which is 22.9.

NYSE:AEP Price Estimation Relative to Market, July 19th 2019

American Electric Power Company's P/E tells us that market participants think its prospects are roughly in line with its industry. So if American Electric Power Company actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's great to see that American Electric Power Company grew EPS by 15% in the last year. And it has bolstered its earnings per share by 3.8% per year over the last five years. So one might expect an above average P/E ratio.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its 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.

How Does American Electric Power Company's Debt Impact Its P/E Ratio?

Net debt totals 58% of American Electric Power Company'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 Bottom Line On American Electric Power Company's P/E Ratio

American Electric Power Company trades on a P/E ratio of 22.2, which is above its market average of 17.9. It has already proven it can grow earnings, but the debt levels mean it faces some risks. But if growth falters, the relatively high P/E ratio may prove to be unjustified.

Investors should be looking to buy stocks that the market is wrong about. 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.

But note: American Electric Power Company may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.