The Southern Company's (NYSE:SO) Shares May Have Run Too Fast Too Soon

With a price-to-earnings (or "P/E") ratio of 21.6x The Southern Company (NYSE:SO) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 14x and even P/E's lower than 8x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Southern certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Southern

Want the full picture on analyst estimates for the company? Then our free report on Southern will help you uncover what's on the horizon.

How Is Southern's Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Southern's to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 12%. However, this wasn't enough as the latest three year period has seen an unpleasant 29% overall drop in EPS. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 10% each year as estimated by the twelve analysts watching the company. That's shaping up to be similar to the 9.0% each year growth forecast for the broader market.

In light of this, it's curious that Southern's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Southern's P/E?

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Southern's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 4 warning signs for Southern you should be aware of, and 1 of them is potentially serious.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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