The Market Is Betting Big on AEP - What's the Catch?

American Electric Power Company, Inc., an electric public utility holding company, engages in the generation, transmission, and distribution of electricity for sale to retail and wholesale customers in the United States. The large-cap Utilities company is based in Columbus, United States and has 16,974 full time employees.

AEP's P/E Ratio Is Comparable to its Sector Average

Compared to the Utilities sector's average of 22.89, American Electric Power Company has a trailing twelve month price to earnings (P/E) ratio of 21.7 and an expected P/E ratio of 15.2. P/E ratios are calculated by dividing the company's share price by either its trailing 12 month ($3.94) or forward earnings per share ($5.62).

Earnings is another term for the net profits left over after subtracting cost of goods sold, taxes, and operating costs from the company's recorded sales revenue. One way of looking at the P/E ratio is that it represents how much investors are willing to pay for every dollar's worth of the company's earnings. Since American Electric Power Company's P/E ratio is near its sector average of 22.89, we can deduce that the market is fairly valuing the company's earnings.

American Electric Power Company Is Overvalued in Terms of Expected Growth

American Electric Power Company's PEG ratio is 3.07. This metric represents the company's earnings per share divided by its expected growth ratio, and is a useful complement to the price to earnings analysis, because it factors in growth to the valuation. A PEG ratio around or below 1 implies that the market in fairly valuing the company in terms of its growth estimates. But when the PEG ratio is higher, as in American Electric Power Company's case, it tells us the company is overvalued.

AEP Has an Average P/B Ratio

Traditionally, stock pickers used to focus primarily on finding issues that were trading significantly below their tangible asset value, to guarantee themselves a margin of safety. But such an approach would screen out many valuable securities because many profitable businesses -- especially those that heavily leverage information technology -- simply do not have many tangible assets compared to more capital intensive companies.

Therefore, modern value investors tend to focus less on absolute price to book value (P/B) ratios. Instead of singling out stocks with a P/B ratio of less than 1, they will compare the target company against its peer group. For American Electric Power Company, the P/B value is 1.85 while the average for the Utilities sector is 1.03.

AEP's Weak Cash Flow Generation Is Troubling

The table below shows that American Electric Power Company is not generating enough cash. A well run company will generally have cash flows that reflect the strength of its underlying business, and in American Electric Power Company's case, free cash flow is growing at an average rate of 5.7% with a coefficient of variability of 21.2%. We can also see that cash flows from operations are evolving at a 5.5% rate, versus 2.5%:

American Electric Power Company's Margins Are Strong

If you buy a stock for the long run, you want the underlying business model to be profitable. Gross margins tell you how much profit the company generates compared to the cost of revenue, which is the cost directly related to providing American Electric Power Company's goods and services. Operating margins, on the other hand, tell you how much of these profits the company keeps after you take overhead into account.

American Electric Power Company's Gross Margins

American Electric Power Company's Operating Margins

American Electric Power Company's cost of revenue is growing at a rate of 7.2% in contrast to 3.7% for operating expenses. Sales revenues, on the other hand, have experienced a 6.0% growth rate. As a result, the average gross margins growth is -0.8 and the average operating margins growth rate is 2.2, with coefficients of variability of 4.5% and 6.3% respectively.

We See Mixed Market Signals Regarding AEP

American Electric Power Company has an average rating of buy and target prices ranging from $113.0 to $87.5. At its current price of $85.32, the company is trading -13.22% away from its target price of $98.32. 1.2% of the company's shares are linked to short positions, and 78.1% of the shares are owned by institutional investors.