Yahoo Finance Here's How P/E Ratios Can Help Us Understand Pennon Group Plc (LON:PNN)
This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Pennon Group Plc's (LON:PNN) P/E ratio could help you assess the value on offer. Pennon Group has a P/E ratio of 14.21, based on the last twelve months. That is equivalent to an earnings yield of about 7.0%.
Check out our latest analysis for Pennon Group
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 Pennon Group:
P/E of 14.21 = £7.26 ÷ £0.51 (Based on the trailing twelve months to March 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. 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 Pennon Group'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 Pennon Group has a P/E ratio that is fairly close for the average for the water utilities industry, which is 14.9.
Pennon Group'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. 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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Pennon Group saw earnings per share improve by -6.4% last year. And its annual EPS growth rate over 5 years is 5.7%.
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. 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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting Pennon Group's P/E?
Pennon Group has net debt worth 58% of its market capitalization. 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 Pennon Group's P/E Ratio
Pennon Group has a P/E of 14.2. That's below the average in the GB market, which is 16.2. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Pennon Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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.
