This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how PPL Corporation’s (NYSE:PPL) P/E ratio could help you assess the value on offer. PPL has a price to earnings ratio of 13.56, based on the last twelve months. That is equivalent to an earnings yield of about 7.4%.
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How Do You Calculate PPL’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for PPL:
P/E of 13.56 = $28.96 ÷ $2.14 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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 Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
PPL saw earnings per share decrease by 3.5% last year. And EPS is down 9.5% a year, over the last 3 years. So you wouldn’t expect a very high P/E.
How Does PPL’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 PPL has a lower P/E than the average (19.4) P/E for companies in the electric utilities industry.
PPL’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with PPL, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does PPL’s Debt Impact Its P/E Ratio?
Net debt totals a substantial 101% of PPL’s market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Verdict On PPL’s P/E Ratio
PPL’s P/E is 13.6 which is below average (16.8) in the US market. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than PPL. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.