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 CenterPoint Energy Inc’s (NYSE:CNP) P/E ratio could help you assess the value on offer. Based on the last twelve months, CenterPoint Energy’s P/E ratio is 7.71. That is equivalent to an earnings yield of about 13%.
How Do You Calculate CenterPoint Energy’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for CenterPoint Energy:
P/E of 7.71 = $27.8 ÷ $3.61 (Based on the trailing twelve months to June 2018.)
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 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
P/E ratios primarily reflect market expectations around earnings growth rates. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that CenterPoint Energy grew EPS by a stonking 156% in the last year. And earnings per share have improved by 27% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does CenterPoint Energy’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that CenterPoint Energy has a lower P/E than the average (16.9) P/E for companies in the integrated utilities industry.
Its relatively low P/E ratio indicates that CenterPoint Energy shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with CenterPoint Energy, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting CenterPoint Energy’s P/E?
CenterPoint Energy has net debt worth 52% 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 Bottom Line On CenterPoint Energy’s P/E Ratio
CenterPoint Energy trades on a P/E ratio of 7.7, which is below the US market average of 18.4. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
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 visual report on analyst forecasts could hold they 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.
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 email@example.com.