This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to AusNet Services Ltd's (ASX:AST), to help you decide if the stock is worth further research. AusNet Services has a P/E ratio of 25.48, based on the last twelve months. That means that at current prices, buyers pay A$25.48 for every A$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for AusNet Services:
P/E of 25.48 = A$1.705 ÷ A$0.067 (Based on the year to September 2019.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does AusNet Services 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. The image below shows that AusNet Services has a P/E ratio that is roughly in line with the electric utilities industry average (27.1).
AusNet Services'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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
AusNet Services's earnings per share fell by 10% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 25%. And it has shrunk its earnings per share by 6.9% per year over the last three years. This might lead to low expectations.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 AusNet Services's Debt Impact Its P/E Ratio?
Net debt totals a substantial 137% of AusNet Services's market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Verdict On AusNet Services's P/E Ratio
AusNet Services's P/E is 25.5 which is above average (12.6) in its market. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 AusNet Services. 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).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.