This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Southwestern Energy Company’s (NYSE:SWN) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Southwestern Energy’s P/E ratio is 5.89. That is equivalent to an earnings yield of about 17%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Southwestern Energy:
P/E of 5.89 = $5.22 ÷ $0.89 (Based on the year to September 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Southwestern Energy increased earnings per share by a whopping 41% last year. And earnings per share have improved by 96% annually, over the last three years. With that performance, I would expect it to have an above average P/E ratio. But earnings per share are down 11% per year over the last five years.
How Does Southwestern 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 Southwestern Energy has a lower P/E than the average (12.8) P/E for companies in the oil and gas industry.
Its relatively low P/E ratio indicates that Southwestern Energy shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
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. 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).
How Does Southwestern Energy’s Debt Impact Its P/E Ratio?
Net debt totals a substantial 118% of Southwestern Energy’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 Southwestern Energy’s P/E Ratio
Southwestern Energy trades on a P/E ratio of 5.9, 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 should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
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 firstname.lastname@example.org.