With a median price-to-earnings (or "P/E") ratio of close to 17x in the United States, you could be forgiven for feeling indifferent about Pinnacle West Capital Corporation's (NYSE:PNW) P/E ratio of 18.4x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
Pinnacle West Capital certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It might be that many expect the strong earnings performance to deteriorate like the rest, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
Does Growth Match The P/E?
The only time you'd be comfortable seeing a P/E like Pinnacle West Capital's is when the company's growth is tracking the market closely.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 3.5% last year. Still, lamentably EPS has fallen 17% in aggregate from three years ago, which is disappointing. 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 6.0% per annum as estimated by the nine analysts watching the company. With the market predicted to deliver 10% growth per year, the company is positioned for a weaker earnings result.
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. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Key Takeaway
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 Pinnacle West Capital's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
You should always think about risks. Case in point, we've spotted 3 warning signs for Pinnacle West Capital you should be aware of, and 1 of them is a bit unpleasant.
If you're unsure about the strength of Pinnacle West Capital's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.