Want to participate in a research study? Help shape the future of investing tools and earn a $60 gift card!
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use First Bancorp's (NASDAQ:FBNC) P/E ratio to inform your assessment of the investment opportunity. First Bancorp has a P/E ratio of 11.3, based on the last twelve months. That means that at current prices, buyers pay $11.3 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 = Price per Share ÷ Earnings per Share (EPS)
Or for First Bancorp:
P/E of 11.3 = $34.13 ÷ $3.02 (Based on the trailing twelve months to December 2018.)
Is A High P/E 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, First Bancorp grew EPS by a whopping 66% in the last year. And its annual EPS growth rate over 5 years is 19%. With that performance, I would expect it to have an above average P/E ratio.
How Does First Bancorp's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that First Bancorp has a lower P/E than the average (12.8) P/E for companies in the banks industry.
First Bancorp's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with First Bancorp, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does First Bancorp's Debt Impact Its P/E Ratio?
First Bancorp has net cash of US$53m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On First Bancorp's P/E Ratio
First Bancorp trades on a P/E ratio of 11.3, which is below the US market average of 17.2. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: First 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 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. Thank you for reading.