Why ABB Ltd’s (VTX:ABBN) High P/E Ratio Isn’t Necessarily A Bad Thing
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at ABB Ltd’s (VTX:ABBN) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, ABB’s P/E ratio is 18.1. That is equivalent to an earnings yield of about 5.5%.
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How Do I Calculate ABB’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for ABB:
P/E of 18.1 = $19.06 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $1.05 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each CHF1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
ABB had pretty flat EPS growth in the last year. But it has grown its earnings per share by 6.5% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 4.3% annually. So we might expect a relatively low P/E.
How Does ABB’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, ABB has a higher P/E than the average company (16.6) in the electrical industry.
Its relatively high P/E ratio indicates that ABB shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
How Does ABB’s Debt Impact Its P/E Ratio?
ABB’s net debt is 15% of its market cap. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Verdict On ABB’s P/E Ratio
ABB’s P/E is 18.1 which is about average (18.2) in the CH market. With modest debt and some recent earnings growth, it seems likely the market expects a steady performance going forward.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
