The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at First Financial Bancorp.’s (NASDAQ:FFBC) P/E ratio and reflect on what it tells us about the company’s share price. First Financial Bancorp has a P/E ratio of 14.32, based on the last twelve months. That means that at current prices, buyers pay $14.32 for every $1 in trailing yearly profits.
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 First Financial Bancorp:
P/E of 14.32 = $25.62 ÷ $1.79 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
First Financial Bancorp increased earnings per share by an impressive 15% over the last twelve months. And it has bolstered its earnings per share by 14% per year over the last five years. With that performance, you might expect an above average P/E ratio.
How Does First Financial Bancorp’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 (15) for companies in the banks industry is roughly the same as First Financial Bancorp’s P/E.
That indicates that the market expects First Financial Bancorp will perform roughly in line with other companies in its industry. So if First Financial Bancorp actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does First Financial Bancorp’s Debt Impact Its P/E Ratio?
First Financial Bancorp has net debt worth 64% of its market capitalization. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Verdict On First Financial Bancorp’s P/E Ratio
First Financial Bancorp has a P/E of 14.3. That’s below the average in the US market, which is 17.2. The company may have significant debt, but EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors have an opportunity when market expectations about a stock are wrong. 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.
But note: First 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.