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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Portland General Electric Company's (NYSE:POR) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Portland General Electric's P/E ratio is 21.88. That corresponds to an earnings yield of approximately 4.6%.
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 Portland General Electric:
P/E of 21.88 = $54.17 ÷ $2.48 (Based on the year to March 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. 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.'
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Portland General Electric increased earnings per share by an impressive 24% over the last twelve months. And earnings per share have improved by 11% annually, over the last five years. This could arguably justify a relatively high P/E ratio.
How Does Portland General Electric's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below Portland General Electric has a P/E ratio that is fairly close for the average for the electric utilities industry, which is 22.1.
Its P/E ratio suggests that Portland General Electric shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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.
Portland General Electric's Balance Sheet
Portland General Electric's net debt equates to 49% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Portland General Electric's P/E Ratio
Portland General Electric has a P/E of 21.9. That's higher than the average in the US market, which is 18.1. While the company does use modest debt, its recent earnings growth is very good. So on this analysis it seems reasonable that its P/E ratio is above average.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.
You might be able to find a better buy than Portland General Electric. 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).
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Thank you for reading.