Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Southwest Gas Holdings, Inc.'s (NYSE:SWX) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Southwest Gas Holdings's P/E ratio is 23.68. That is equivalent to an earnings yield of about 4.2%.
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 Southwest Gas Holdings:
P/E of 23.68 = $90.51 ÷ $3.82 (Based on the year to June 2019.)
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 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 Southwest Gas Holdings 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. If you look at the image below, you can see Southwest Gas Holdings has a lower P/E than the average (26.2) in the gas utilities industry classification.
This suggests that market participants think Southwest Gas Holdings 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
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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Southwest Gas Holdings shrunk earnings per share by 11% over the last year. But over the longer term (5 years) earnings per share have increased by 5.6%.
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).
So What Does Southwest Gas Holdings's Balance Sheet Tell Us?
Net debt is 48% of Southwest Gas Holdings's market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Southwest Gas Holdings's P/E Ratio
Southwest Gas Holdings trades on a P/E ratio of 23.7, which is above its market average of 18.0. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors should be looking to buy stocks that the market is wrong about. 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.
You might be able to find a better buy than Southwest Gas Holdings. 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.