The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Bar Harbor Bankshares’s (NYSEMKT:BHB) P/E ratio to inform your assessment of the investment opportunity. Bar Harbor Bankshares has a P/E ratio of 12.39, based on the last twelve months. That corresponds to an earnings yield of approximately 8.1%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Bar Harbor Bankshares:
P/E of 12.39 = $25.58 ÷ $2.06 (Based on the trailing twelve months to September 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, Bar Harbor Bankshares grew EPS by a whopping 28% in the last year. And it has bolstered its earnings per share by 3.9% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Bar Harbor Bankshares’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Bar Harbor Bankshares has a lower P/E than the average (15.5) in the banks industry classification.
Its relatively low P/E ratio indicates that Bar Harbor Bankshares shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Bar Harbor Bankshares, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Bar Harbor Bankshares’s Debt Impact Its P/E Ratio?
Net debt totals a substantial 179% of Bar Harbor Bankshares’s market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Verdict On Bar Harbor Bankshares’s P/E Ratio
Bar Harbor Bankshares’s P/E is 12.4 which is below average (18.5) in the US market. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors should be looking to buy stocks that the market is wrong about. 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.’ Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Bar Harbor Bankshares. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.