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 Eagle Financial Bancorp, Inc.'s (NASDAQ:EFBI) P/E ratio could help you assess the value on offer. Eagle Financial Bancorp has a price to earnings ratio of 79.78, based on the last twelve months. That corresponds to an earnings yield of approximately 1.3%.
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 Eagle Financial Bancorp:
P/E of 79.78 = $15.76 ÷ $0.20 (Based on the year to March 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 Eagle Financial Bancorp's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Eagle Financial Bancorp has a significantly higher P/E than the average (13.6) P/E for companies in the mortgage industry.
Eagle Financial Bancorp's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Eagle Financial Bancorp increased earnings per share by an impressive 22% over the last twelve months.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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 Eagle Financial Bancorp's P/E?
With net cash of US$9.8m, Eagle Financial Bancorp has a very strong balance sheet, which may be important for its business. Having said that, at 41% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Eagle Financial Bancorp's P/E Ratio
Eagle Financial Bancorp's P/E is 79.8 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With cash in the bank the company has plenty of growth options -- and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: Eagle Financial Bancorp 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).
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 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. Thank you for reading.