The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Boston Private Financial Holdings, Inc.'s (NASDAQ:BPFH) P/E ratio could help you assess the value on offer. Boston Private Financial Holdings has a price to earnings ratio of 9.84, based on the last twelve months. That corresponds to an earnings yield of approximately 10.2%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Boston Private Financial Holdings:
P/E of 9.84 = $11.25 ÷ $1.14 (Based on the year to September 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Boston Private Financial Holdings's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (12.6) for companies in the banks industry is higher than Boston Private Financial Holdings's P/E.
This suggests that market participants think Boston Private Financial Holdings will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Boston Private Financial Holdings's 383% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 16% per year over three years. So we'd absolutely expect it to have a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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.
Boston Private Financial Holdings's Balance Sheet
Boston Private Financial Holdings has net debt worth 94% of its market capitalization. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Boston Private Financial Holdings's P/E Ratio
Boston Private Financial Holdings trades on a P/E ratio of 9.8, which is below the US market average of 18.1. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 Boston Private Financial Holdings. 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 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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