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 Credicorp Ltd.'s (NYSE:BAP) P/E ratio could help you assess the value on offer. Credicorp has a P/E ratio of 13.38, based on the last twelve months. That is equivalent to an earnings yield of about 7.5%.
How Do I Calculate Credicorp's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Credicorp:
P/E of 13.38 = $714.50 (Note: this is the share price in the reporting currency, namely, PEN ) ÷ $53.41 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Credicorp Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Credicorp has a P/E ratio that is roughly in line with the banks industry average (13.1).
That indicates that the market expects Credicorp will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Credicorp's earnings per share grew by -3.6% in the last twelve months. And earnings per share have improved by 13% annually, 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. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting Credicorp's P/E?
The extra options and safety that comes with Credicorp's S/5.0b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Credicorp's P/E Ratio
Credicorp has a P/E of 13.4. That's below the average in the US market, which is 18.9. Earnings improved over the last year. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don't think it will. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here.
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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Credicorp 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 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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