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Is American Water Works Company, Inc.'s (NYSE:AWK) P/E Ratio Really That Good?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at American Water Works Company, Inc.'s (NYSE:AWK) P/E ratio and reflect on what it tells us about the company's share price. American Water Works Company has a price to earnings ratio of 39.12, based on the last twelve months. That is equivalent to an earnings yield of about 2.6%.

View our latest analysis for American Water Works Company

How Do I Calculate American Water Works 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 Water Works Company:

P/E of 39.12 = $125.78 ÷ $3.22 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

Does American Water Works Company 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. As you can see below American Water Works Company has a P/E ratio that is fairly close for the average for the water utilities industry, which is 39.4.

NYSE:AWK Price Estimation Relative to Market, October 8th 2019

Its P/E ratio suggests that American Water Works Company shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's great to see that American Water Works Company grew EPS by 22% in the last year. And it has bolstered its earnings per share by 8.0% per year over the last five years. With that performance, you might expect an above average P/E ratio.

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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

American Water Works Company's Balance Sheet

American Water Works Company's net debt equates to 40% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On American Water Works Company's P/E Ratio

American Water Works Company's P/E is 39.1 which is above average (17.6) in its market. While the company does use modest debt, its recent earnings growth is very good. Therefore, it's not particularly surprising that it has a above average P/E ratio.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: American Water Works 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.