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Is Cortland Bancorp's (NASDAQ:CLDB) High P/E Ratio A Problem For Investors?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Cortland Bancorp's (NASDAQ:CLDB), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Cortland Bancorp has a P/E ratio of 12.75. That is equivalent to an earnings yield of about 7.8%.

View our latest analysis for Cortland Bancorp

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Cortland Bancorp:

P/E of 12.75 = $21.85 ÷ $1.71 (Based on the trailing twelve months to June 2019.)

Is A High P/E 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. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

Does Cortland Bancorp Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. As you can see below Cortland Bancorp has a P/E ratio that is fairly close for the average for the banks industry, which is 12.4.

NasdaqCM:CLDB Price Estimation Relative to Market, October 10th 2019
NasdaqCM:CLDB Price Estimation Relative to Market, October 10th 2019

That indicates that the market expects Cortland Bancorp will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Cortland Bancorp increased earnings per share by 7.4% last year. And earnings per share have improved by 25% annually, over the last five years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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.

So What Does Cortland Bancorp's Balance Sheet Tell Us?

Cortland Bancorp's net debt is 4.8% of its market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Cortland Bancorp's P/E Ratio

Cortland Bancorp's P/E is 12.8 which is below average (17.3) in the US market. The company does have a little debt, and EPS is moving in the right direction. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.