Yahoo Finance Should You Be Tempted To Sell Algonquin Power & Utilities Corp (TSE:AQN) At Its Current PE Ratio?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Algonquin Power & Utilities Corp (TSE:AQN) is currently trading at a trailing P/E of 74.7, which is higher than the industry average of 17.2. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Check out our latest analysis for Algonquin Power & Utilities
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for AQN
Price-Earnings Ratio = Price per share ÷ Earnings per share
AQN Price-Earnings Ratio = $10.34 ÷ $0.138 = 74.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AQN, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 74.7, AQN’s P/E is higher than its industry peers (17.2). This implies that investors are overvaluing each dollar of AQN’s earnings. Since the Integrated Utilities sector in CA is relatively small, I’ve included similar companies in the wider region in order to get a better idea of the multiple, which is a median of profitable companies of companies such as Just Energy Group, ATCO and Canadian Utilities. You could think of it like this: the market is pricing AQN as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to AQN. If this isn’t the case, the difference in P/E could be due to other factors. For example, Algonquin Power & Utilities Corp could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with AQN are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
Since you may have already conducted your due diligence on AQN, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for AQN’s future growth? Take a look at our free research report of analyst consensus for AQN’s outlook.
Past Track Record: Has AQN been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of AQN’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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.
