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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Northwest Natural Holding Company's (NYSE:NWN) P/E ratio and reflect on what it tells us about the company's share price. Northwest Natural Holding has a P/E ratio of 28.6, based on the last twelve months. In other words, at today's prices, investors are paying $28.6 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Northwest Natural Holding:
P/E of 28.6 = $66.84 ÷ $2.34 (Based on the trailing twelve months to December 2018.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. 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.
Northwest Natural Holding shrunk earnings per share by 7.0% last year. But EPS is up 6.0% over the last 3 years.
Does Northwest Natural Holding Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (25) for companies in the gas utilities industry is lower than Northwest Natural Holding's P/E.
Its relatively high P/E ratio indicates that Northwest Natural Holding shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
How Does Northwest Natural Holding's Debt Impact Its P/E Ratio?
Northwest Natural Holding's net debt equates to 49% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Northwest Natural Holding's P/E Ratio
Northwest Natural Holding trades on a P/E ratio of 28.6, which is above the US market average of 18.1. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Northwest Natural Holding. 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 email@example.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. Thank you for reading.