Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Black Hills Corporation's (NYSE:BKH) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Black Hills has a P/E ratio of 21.94. That means that at current prices, buyers pay $21.94 for every $1 in trailing yearly profits.
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 Black Hills:
P/E of 21.94 = USD80.02 ÷ USD3.65 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each USD1 of company earnings. 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 Does Black Hills's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Black Hills has a P/E ratio that is fairly close for the average for the integrated utilities industry, which is 21.3.
Black Hills's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
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. 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.
Black Hills shrunk earnings per share by 20% over the last year. But it has grown its earnings per share by 6.5% per year over the last five years.
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. That means it doesn't take debt or cash into account. 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.
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).
Black Hills's Balance Sheet
Net debt totals 69% of Black Hills's market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Black Hills's P/E Ratio
Black Hills trades on a P/E ratio of 21.9, which is above its market average of 18.9. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Black Hills. 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 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.
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.