It's not a stretch to say that Pinnacle West Capital Corporation's (NYSE:PNW) price-to-earnings (or "P/E") ratio of 16.9x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 17x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
With earnings that are retreating more than the market's of late, Pinnacle West Capital has been very sluggish. One possibility is that the P/E is moderate because investors think the company's earnings trend will eventually fall in line with most others in the market. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. If not, then existing shareholders may be a little nervous about the viability of the share price.
See our latest analysis for Pinnacle West Capital
What Are Growth Metrics Telling Us About The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like Pinnacle West Capital's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 11%. The last three years don't look nice either as the company has shrunk EPS by 25% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 7.7% each year over the next three years. That's shaping up to be materially lower than the 13% per annum growth forecast for the broader market.
With this information, we find it interesting that Pinnacle West Capital is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Final Word
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that Pinnacle West Capital currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Having said that, be aware Pinnacle West Capital is showing 2 warning signs in our investment analysis, and 1 of those is a bit concerning.
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 a strong growth track record, trading on a low P/E.
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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.