Read This Before You Buy TransCanada Corporation (TSE:TRP) Because Of Its P/E Ratio

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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 TransCanada Corporation’s (TSE:TRP) P/E ratio could help you assess the value on offer. TransCanada has a price to earnings ratio of 14.75, based on the last twelve months. That corresponds to an earnings yield of approximately 6.8%.

See our latest analysis for TransCanada

How Do You Calculate TransCanada’s P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for TransCanada:

P/E of 14.75 = CA$54.64 ÷ CA$3.7 (Based on the year to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CA$1 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 Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.

Notably, TransCanada grew EPS by a whopping 79% in the last year. And earnings per share have improved by 1.5% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.

How Does TransCanada’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (14.9) for companies in the oil and gas industry is roughly the same as TransCanada’s P/E.

TSX:TRP PE PEG Gauge February 12th 19

TransCanada’s P/E tells us that market participants think its prospects are roughly in line with its industry. So if TransCanada actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

How Does TransCanada’s Debt Impact Its P/E Ratio?

TransCanada has net debt worth 92% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Verdict On TransCanada’s P/E Ratio

TransCanada’s P/E is 14.8 which is about average (14.6) in the CA market. The significant levels of debt do detract somewhat from the strong earnings growth. However, the P/E ratio implies that most doubt the strong growth will continue.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold they key to an excellent investment decision.

Of course you might be able to find a better stock than TransCanada. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.