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 C&F Financial Corporation’s (NASDAQ:CFFI) P/E ratio could help you assess the value on offer. C&F Financial has a P/E ratio of 16.92, based on the last twelve months. That is equivalent to an earnings yield of about 5.9%.
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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 C&F Financial:
P/E of 16.92 = $51.97 ÷ $3.07 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
C&F Financial shrunk earnings per share by 18% over the last year. And it has shrunk its earnings per share by 8.5% per year over the last five years. This could justify a pessimistic P/E.
How Does C&F Financial’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (14.6) for companies in the banks industry is lower than C&F Financial’s P/E.
Its relatively high P/E ratio indicates that C&F Financial 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. 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 C&F Financial’s Debt Impact Its P/E Ratio?
Net debt totals 26% of C&F Financial’s market cap. 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 Bottom Line On C&F Financial’s P/E Ratio
C&F Financial’s P/E is 16.9 which is about average (16.8) in the US market. With modest debt, and a lack of recent growth, it would seem the market is expecting improvement in earnings.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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 email@example.com.