To the annoyance of some shareholders, MGE Energy (NASDAQ:MGEE) shares are down a considerable 33% in the last month. The recent drop has obliterated the annual return, with the share price now down 18% over that longer period.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does MGE Energy's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 21.66 that there is some investor optimism about MGE Energy. The image below shows that MGE Energy has a higher P/E than the average (18.5) P/E for companies in the electric utilities industry.
That means that the market expects MGE Energy will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.
MGE Energy's earnings per share grew by -3.2% in the last twelve months. And its annual EPS growth rate over 5 years is 1.6%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
Is Debt Impacting MGE Energy's P/E?
Net debt is 28% of MGE Energy's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On MGE Energy's P/E Ratio
MGE Energy has a P/E of 21.7. That's higher than the average in its market, which is 13.3. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future. Given MGE Energy's P/E ratio has declined from 32.2 to 21.7 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
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.
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.
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