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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at AltaGas Ltd.'s (TSE:ALA) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, AltaGas has a P/E ratio of 17.38. That means that at current prices, buyers pay CA$17.38 for every CA$1 in trailing yearly profits.
Check out our latest analysis for AltaGas
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for AltaGas:
P/E of 17.38 = CA$19.06 ÷ CA$1.1 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each CA$1 the company has earned over the last year. 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.'
Does AltaGas 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. As you can see below AltaGas has a P/E ratio that is fairly close for the average for the gas utilities industry, which is 17.4.
That indicates that the market expects AltaGas will perform roughly in line with other companies in its industry. So if AltaGas actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. 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.
AltaGas's earnings made like a rocket, taking off 239% last year. Even better, EPS is up 63% per year over three years. So you might say it really deserves to have an above-average P/E ratio. Unfortunately, earnings per share are down 4.2% a year, over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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.