The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Pinnacle West Capital Corporation's (NYSE:PNW) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Pinnacle West Capital has a P/E ratio of 21.80. In other words, at today's prices, investors are paying $21.80 for every $1 in prior year profit.
How Do I Calculate Pinnacle West Capital's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Pinnacle West Capital:
P/E of 21.80 = $97.67 ÷ $4.48 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company 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.
Does Pinnacle West Capital Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Pinnacle West Capital has a lower P/E than the average (24.0) in the electric utilities industry classification.
This suggests that market participants think Pinnacle West Capital will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Pinnacle West Capital increased earnings per share by 7.3% last year. And it has bolstered its earnings per share by 4.4% per year over the last five years.
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. That means it doesn't take debt or cash into account. 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.
How Does Pinnacle West Capital's Debt Impact Its P/E Ratio?
Net debt totals 51% of Pinnacle West Capital's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Pinnacle West Capital's P/E Ratio
Pinnacle West Capital's P/E is 21.8 which is above average (17.8) in its market. With relatively high debt, and reasonably modest earnings per share growth over twelve months, it's safe to say the market believes the company will improve its growth in the future.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Pinnacle West Capital. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.