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Should You Be Tempted To Sell Aqua America, Inc. (NYSE:WTR) Because Of Its P/E Ratio?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Aqua America, Inc.'s (NYSE:WTR) P/E ratio and reflect on what it tells us about the company's share price. What is Aqua America's P/E ratio? Well, based on the last twelve months it is 57.11. That means that at current prices, buyers pay $57.11 for every $1 in trailing yearly profits.

View our latest analysis for Aqua America

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Aqua America:

P/E of 57.11 = $44.30 ÷ $0.78 (Based on the trailing twelve months to September 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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

Does Aqua America 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. As you can see below, Aqua America has a higher P/E than the average company (38.9) in the water utilities industry.

NYSE:WTR Price Estimation Relative to Market, November 6th 2019

Its relatively high P/E ratio indicates that Aqua America shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Aqua America shrunk earnings per share by 45% over the last year. And over the longer term (5 years) earnings per share have decreased 8.3% annually. This could justify a pessimistic P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

How Does Aqua America's Debt Impact Its P/E Ratio?

Aqua America has net debt worth 11% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Aqua America's P/E Ratio

With a P/E ratio of 57.1, Aqua America is expected to grow earnings very strongly in the years to come. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Aqua America may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.