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Here's What Consolidated Water Co. Ltd.'s (NASDAQ:CWCO) P/E Ratio Is Telling Us

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Consolidated Water Co. Ltd.'s (NASDAQ:CWCO) P/E ratio to inform your assessment of the investment opportunity. Consolidated Water has a P/E ratio of 29.41, based on the last twelve months. That means that at current prices, buyers pay $29.41 for every $1 in trailing yearly profits.

See our latest analysis for Consolidated Water

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Consolidated Water:

P/E of 29.41 = USD17.58 ÷ USD0.60 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

Does Consolidated Water 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. The image below shows that Consolidated Water has a lower P/E than the average (38.6) P/E for companies in the water utilities industry.

NasdaqGS:CWCO Price Estimation Relative to Market, January 30th 2020
NasdaqGS:CWCO Price Estimation Relative to Market, January 30th 2020

This suggests that market participants think Consolidated Water will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Consolidated Water increased earnings per share by 3.5% last year. And its annual EPS growth rate over 5 years is 6.6%.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

Is Debt Impacting Consolidated Water's P/E?

Consolidated Water has net cash of US$42m. This is fairly high at 16% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Consolidated Water's P/E Ratio

Consolidated Water trades on a P/E ratio of 29.4, which is above its market average of 18.4. Recent earnings growth wasn't bad. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

But note: Consolidated Water may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.

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