Yahoo Finance Why Meridian Energy Limited's (NZSE:MEL) High P/E Ratio Isn't Necessarily A Bad Thing
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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Meridian Energy Limited's (NZSE:MEL) P/E ratio and reflect on what it tells us about the company's share price. What is Meridian Energy's P/E ratio? Well, based on the last twelve months it is 44.75. That is equivalent to an earnings yield of about 2.2%.
View our latest analysis for Meridian Energy
How Do I Calculate Meridian Energy's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Meridian Energy:
P/E of 44.75 = NZ$4.26 ÷ NZ$0.095 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
It's nice to see that Meridian Energy grew EPS by a stonking 33% in the last year. And it has improved its earnings per share by 1.4% per year over the last three years. So we'd generally expect it to have a relatively high P/E ratio.
Does Meridian Energy Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (16.9) for companies in the renewable energy industry is lower than Meridian Energy's P/E.
That means that the market expects Meridian Energy will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Meridian Energy's Balance Sheet
Net debt totals 14% of Meridian Energy's market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On Meridian Energy's P/E Ratio
Meridian Energy trades on a P/E ratio of 44.7, which is above the NZ market average of 18.1. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So on this analysis a high P/E ratio seems reasonable.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Meridian Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 editorial-team@simplywallst.com. 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.
