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A Rising Share Price Has Us Looking Closely At Eaton Corporation plc's (NYSE:ETN) P/E Ratio

Eaton (NYSE:ETN) shareholders are no doubt pleased to see that the share price has bounced 33% in the last month alone, although it is still down 21% over the last quarter. The bad news is that even after that recovery shareholders are still underwater by about 9.9% for the full year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

See our latest analysis for Eaton

Does Eaton Have A Relatively High Or Low P/E For Its Industry?

Eaton has a P/E ratio of 14.57. You can see in the image below that the average P/E (15.1) for companies in the electrical industry is roughly the same as Eaton's P/E.

NYSE:ETN Price Estimation Relative to Market April 22nd 2020
NYSE:ETN Price Estimation Relative to Market April 22nd 2020

That indicates that the market expects Eaton will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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.

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Eaton increased earnings per share by 6.8% last year. And earnings per share have improved by 6.9% annually, over the last five years.

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

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does Eaton's Debt Impact Its P/E Ratio?

Eaton's net debt is 25% of its 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 Eaton's P/E Ratio

Eaton's P/E is 14.6 which is above average (13.3) in its market. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future. What is very clear is that the market has become more optimistic about Eaton over the last month, with the P/E ratio rising from 10.9 back then to 14.6 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Eaton. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.