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Despite Its High P/E Ratio, Is Equity Bancshares, Inc. (NASDAQ:EQBK) Still Undervalued?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Equity Bancshares, Inc.'s (NASDAQ:EQBK) P/E ratio to inform your assessment of the investment opportunity. Equity Bancshares has a price to earnings ratio of 16.79, based on the last twelve months. That is equivalent to an earnings yield of about 6.0%.

Check out our latest analysis for Equity Bancshares

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 Equity Bancshares:

P/E of 16.79 = USD27.25 ÷ USD1.62 (Based on the year to September 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each USD1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Does Equity Bancshares's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (12.8) for companies in the banks industry is lower than Equity Bancshares's P/E.

NasdaqGS:EQBK Price Estimation Relative to Market, January 23rd 2020

That means that the market expects Equity Bancshares will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Equity Bancshares's earnings per share fell by 20% in the last twelve months. But it has grown its earnings per share by 4.3% per year over the last five years.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Equity Bancshares's Balance Sheet

Net debt totals 73% of Equity Bancshares's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On Equity Bancshares's P/E Ratio

Equity Bancshares has a P/E of 16.8. That's below the average in the US market, which is 18.8. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Equity Bancshares. 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 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.

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.