Unfortunately for some shareholders, the IF Bancorp (NASDAQ:IROQ) share price has dived 34% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 28% in the last year.
All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does IF Bancorp's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 12.61 that there is some investor optimism about IF Bancorp. You can see in the image below that the average P/E (10.4) for companies in the mortgage industry is lower than IF Bancorp's P/E.
Its relatively high P/E ratio indicates that IF Bancorp shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
It's nice to see that IF Bancorp grew EPS by a stonking 35% in the last year. And earnings per share have improved by 7.0% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
So What Does IF Bancorp's Balance Sheet Tell Us?
Net debt totals 57% of IF Bancorp's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On IF Bancorp's P/E Ratio
IF Bancorp has a P/E of 12.6. That's around the same as the average in the US market, which is 12.6. The significant levels of debt do detract somewhat from the strong earnings growth. The P/E suggests the market isn't confident that growth will be sustained, though. What can be absolutely certain is that the market has become significantly less optimistic about IF Bancorp over the last month, with the P/E ratio falling from 19.1 back then to 12.6 today. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than IF Bancorp. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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