The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Ames National Corporation’s (NASDAQ:ATLO) P/E ratio and reflect on what it tells us about the company’s share price. Ames National has a P/E ratio of 13.81, based on the last twelve months. In other words, at today’s prices, investors are paying $13.81 for every $1 in prior year profit.
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How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ames National:
P/E of 13.81 = $25.27 ÷ $1.83 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Most would be impressed by Ames National earnings growth of 24% in the last year.
How Does Ames National’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below Ames National has a P/E ratio that is fairly close for the average for the banks industry, which is 14.5.
Its P/E ratio suggests that Ames National shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting Ames National’s P/E?
Since Ames National holds net cash of US$1.2m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Ames National’s P/E Ratio
Ames National’s P/E is 13.8 which is below average (17.1) in the US market. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Ames National may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.