The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Xcel Energy Inc.'s (NASDAQ:XEL) P/E ratio and reflect on what it tells us about the company's share price. Xcel Energy has a P/E ratio of 25.86, based on the last twelve months. That means that at current prices, buyers pay $25.86 for every $1 in trailing yearly profits.
How Do I Calculate Xcel Energy's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Xcel Energy:
P/E of 25.86 = $63.28 ÷ $2.45 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Xcel 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 Xcel Energy has a higher P/E than the average (23.4) P/E for companies in the electric utilities industry.
Xcel Energy's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Xcel Energy had pretty flat EPS growth in the last year. But over the longer term (5 years) earnings per share have increased by 4.7%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
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).
How Does Xcel Energy's Debt Impact Its P/E Ratio?
Net debt totals 54% of Xcel Energy's market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On Xcel Energy's P/E Ratio
Xcel Energy has a P/E of 25.9. That's higher than the average in its market, which is 17.5. With meaningful debt and only modest recent earnings growth, the market is either expecting reliable long-term growth, or a near-term improvement.
Investors have an opportunity when market expectations about a stock are wrong. 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 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.
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If you spot an error that warrants correction, please contact the editor at email@example.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.