This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Black Hills Corporation (NYSE:BKH) trades with a trailing P/E of 12.1x, which is lower than the industry average of 16.8x. While this makes BKH appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for BKH
Price-Earnings Ratio = Price per share ÷ Earnings per share
BKH Price-Earnings Ratio = $57.27 ÷ $4.746 = 12.1x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to BKH, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. BKH’s P/E of 12.1 is lower than its industry peers (16.8), which implies that each dollar of BKH’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Integrated Utilities companies in US including Just Energy Group, E.ON and E.ON. You can think of it like this: the market is suggesting that BKH is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to BKH. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with BKH, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing BKH to are fairly valued by the market. If this does not hold true, BKH’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to BKH. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for BKH’s future growth? Take a look at our free research report of analyst consensus for BKH’s outlook.
- Past Track Record: Has BKH been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of BKH’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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.