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 Ringkjøbing Landbobank A/S's (CPH:RILBA) P/E ratio could help you assess the value on offer. Based on the last twelve months, Ringkjøbing Landbobank's P/E ratio is 18.07. That means that at current prices, buyers pay DKK18.07 for every DKK1 in trailing yearly profits.
How Do I Calculate Ringkjøbing Landbobank's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ringkjøbing Landbobank:
P/E of 18.07 = DKK491.00 ÷ DKK27.17 (Based on the trailing twelve months to September 2019.)
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. 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 Does Ringkjøbing Landbobank's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Ringkjøbing Landbobank has a higher P/E than the average (7.0) P/E for companies in the banks industry.
That means that the market expects Ringkjøbing Landbobank will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Ringkjøbing Landbobank's earnings per share were pretty steady over the last year. But EPS is up 7.6% over the last 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. 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 investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Ringkjøbing Landbobank's Debt Impact Its P/E Ratio?
Net debt is 42% of Ringkjøbing Landbobank's market cap. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Ringkjøbing Landbobank's P/E Ratio
Ringkjøbing Landbobank trades on a P/E ratio of 18.1, which is above its market average of 15.4. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement.
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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Ringkjøbing Landbobank may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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. Thank you for reading.