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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how REN - Redes Energéticas Nacionais, SGPS, S.A.'s (ELI:RENE) P/E ratio could help you assess the value on offer. REN - Redes Energéticas Nacionais SGPS has a price to earnings ratio of 14.22, based on the last twelve months. That is equivalent to an earnings yield of about 7.0%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for REN - Redes Energéticas Nacionais SGPS:
P/E of 14.22 = €2.49 ÷ €0.17 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.'
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
REN - Redes Energéticas Nacionais SGPS's earnings per share fell by 3.0% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 4.8% annually. So it would be surprising to see a high P/E.
Does REN - Redes Energéticas Nacionais SGPS Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (20.6) for companies in the integrated utilities industry is higher than REN - Redes Energéticas Nacionais SGPS's P/E.
This suggests that market participants think REN - Redes Energéticas Nacionais SGPS will underperform other companies in its industry. Since the market seems unimpressed with REN - Redes Energéticas Nacionais SGPS, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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.
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.
So What Does REN - Redes Energéticas Nacionais SGPS's Balance Sheet Tell Us?
Net debt totals a substantial 161% of REN - Redes Energéticas Nacionais SGPS's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On REN - Redes Energéticas Nacionais SGPS's P/E Ratio
REN - Redes Energéticas Nacionais SGPS trades on a P/E ratio of 14.2, which is fairly close to the PT market average of 14.2. With relatively high debt, and no earnings per share growth over twelve months, the P/E suggests that many have an expectation that company will find some growth.
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.
But note: REN - Redes Energéticas Nacionais SGPS 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 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. Thank you for reading.