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A Rising Share Price Has Us Looking Closely At Sempra Energy's (NYSE:SRE) P/E Ratio

Sempra Energy (NYSE:SRE) shareholders are no doubt pleased to see that the share price has bounced 44% in the last month alone, although it is still down 18% over the last quarter. While recent buyers might be laughing, long term holders might not be so pleased, since the recent gain only brings the full year return to evens.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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. So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

Check out our latest analysis for Sempra Energy

How Does Sempra Energy's P/E Ratio Compare To Its Peers?

Sempra Energy's P/E is 21.01. You can see in the image below that the average P/E (20.6) for companies in the integrated utilities industry is roughly the same as Sempra Energy's P/E.

NYSE:SRE Price Estimation Relative to Market April 15th 2020
NYSE:SRE Price Estimation Relative to Market April 15th 2020

Sempra Energy's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Sempra Energy 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

In the last year, Sempra Energy grew EPS like Taylor Swift grew her fan base back in 2010; the 122% gain was both fast and well deserved. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 3.6%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Sempra Energy's Balance Sheet Tell Us?

Sempra Energy's net debt is 66% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Verdict On Sempra Energy's P/E Ratio

Sempra Energy trades on a P/E ratio of 21.0, which is above its market average of 13.7. While its debt levels are rather high, at least its EPS is growing quickly. So despite the debt it is, perhaps, not unreasonable to see a high P/E ratio. What is very clear is that the market has become significantly more optimistic about Sempra Energy over the last month, with the P/E ratio rising from 14.6 back then to 21.0 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.

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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Sempra Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.

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