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Is Quanta Services, Inc.'s (NYSE:PWR) High P/E Ratio A Problem For Investors?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Quanta Services, Inc.'s (NYSE:PWR) P/E ratio and reflect on what it tells us about the company's share price. What is Quanta Services's P/E ratio? Well, based on the last twelve months it is 17.48. That means that at current prices, buyers pay $17.48 for every $1 in trailing yearly profits.

Check out our latest analysis for Quanta Services

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 Quanta Services:

P/E of 17.48 = $38.82 ÷ $2.22 (Based on the year to June 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. 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.

How Does Quanta Services's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below Quanta Services has a P/E ratio that is fairly close for the average for the construction industry, which is 17.2.

NYSE:PWR Price Estimation Relative to Market, October 14th 2019

That indicates that the market expects Quanta Services will perform roughly in line with other companies in its industry. So if Quanta Services actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Quanta Services increased earnings per share by an impressive 10% over the last twelve months. And earnings per share have improved by 4.9% annually, over the last five years. So one might expect an above average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Quanta Services's Balance Sheet Tell Us?

Net debt is 27% of Quanta Services's market cap. While it's worth keeping this in mind, it isn't a worry.

The Bottom Line On Quanta Services's P/E Ratio

Quanta Services has a P/E of 17.5. That's around the same as the average in the US market, which is 17.5. When you consider the impressive EPS growth last year (along with some debt), it seems the market has questions about whether rapid EPS growth will be sustained. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.

Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

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.

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 editorial-team@simplywallst.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.