With a price-to-earnings (or "P/E") ratio of 25.7x The Southern Company (NYSE:SO) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 13x and even P/E's lower than 7x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Southern could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Southern.
How Is Southern's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as steep as Southern's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a frustrating 4.2% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 33% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Turning to the outlook, the next three years should generate growth of 14% per year as estimated by the twelve analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 9.6% per year, which is noticeably less attractive.
With this information, we can see why Southern is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that Southern maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
You should always think about risks. Case in point, we've spotted 2 warning signs for Southern you should be aware of.
If you're unsure about the strength of Southern's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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