Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use National Fuel Gas Company's (NYSE:NFG) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, National Fuel Gas's P/E ratio is 13.40. That means that at current prices, buyers pay $13.40 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for National Fuel Gas:
P/E of 13.40 = $47.30 ÷ $3.53 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Does National Fuel Gas Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (25.6) for companies in the gas utilities industry is higher than National Fuel Gas's P/E.
National Fuel Gas's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
National Fuel Gas's earnings per share fell by 23% in the last twelve months.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 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.
How Does National Fuel Gas's Debt Impact Its P/E Ratio?
National Fuel Gas has net debt worth 54% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On National Fuel Gas's P/E Ratio
National Fuel Gas has a P/E of 13.4. That's below the average in the US market, which is 18.8. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than National Fuel Gas. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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