Is Unitil Corporation's (NYSE:UTL) High P/E Ratio A Problem For Investors?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Unitil Corporation's (NYSE:UTL) P/E ratio could help you assess the value on offer. Unitil has a price to earnings ratio of 21.37, based on the last twelve months. That is equivalent to an earnings yield of about 4.7%.

Check out our latest analysis for Unitil

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Unitil:

P/E of 21.37 = USD63.40 ÷ USD2.97 (Based on the trailing twelve months to December 2019.)

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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

Does Unitil 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 Unitil has a P/E ratio that is fairly close for the average for the integrated utilities industry, which is 21.4.

Unitil's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Unitil 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Unitil increased earnings per share by a whopping 33% last year. And it has bolstered its earnings per share by 11% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Is Debt Impacting Unitil's P/E?

Unitil's net debt is 54% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Verdict On Unitil's P/E Ratio

Unitil's P/E is 21.4 which is above average (18.4) in its market. Its meaningful level of debt should warrant a lower P/E ratio, but the fast EPS growth is a positive. So it seems likely the market is overlooking the debt because of the fast earnings growth.

Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.

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. Thank you for reading.