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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Capstar Financial Holdings, Inc.'s (NASDAQ:CSTR) P/E ratio to inform your assessment of the investment opportunity. Capstar Financial Holdings has a price to earnings ratio of 19.77, based on the last twelve months. That means that at current prices, buyers pay $19.77 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Capstar Financial Holdings:
P/E of 19.77 = $15.01 ÷ $0.76 (Based on the year to March 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. 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 Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
In the last year, Capstar Financial Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 98% gain was both fast and well deserved. Unfortunately, earnings per share are down 4.9% a year, over 3 years.
Does Capstar Financial Holdings Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (13) for companies in the banks industry is lower than Capstar Financial Holdings's P/E.
That means that the market expects Capstar Financial Holdings 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.
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. 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.
How Does Capstar Financial Holdings's Debt Impact Its P/E Ratio?
Capstar Financial Holdings has net cash of US$31m. This is fairly high at 12% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Capstar Financial Holdings's P/E Ratio
Capstar Financial Holdings trades on a P/E ratio of 19.8, which is above the US market average of 18.1. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Capstar Financial Holdings to have a high P/E ratio.
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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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 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.