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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 Home Federal Bancorp, Inc. of Louisiana’s (NASDAQ:HFBL) P/E ratio could help you assess the value on offer. Home Federal Bancorp of Louisiana has a P/E ratio of 11.87, based on the last twelve months. In other words, at today’s prices, investors are paying $11.87 for every $1 in prior year profit.
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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 Home Federal Bancorp of Louisiana:
P/E of 11.87 = $30.5 ÷ $2.57 (Based on the trailing twelve months to December 2018.)
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 Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Home Federal Bancorp of Louisiana increased earnings per share by a whopping 43% last year. And earnings per share have improved by 10% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Home Federal Bancorp of Louisiana’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 Home Federal Bancorp of Louisiana has a lower P/E than the average (16.1) P/E for companies in the mortgage industry.
Home Federal Bancorp of Louisiana’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 Home Federal Bancorp of Louisiana, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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 Home Federal Bancorp of Louisiana’s Debt Impact Its P/E Ratio?
Home Federal Bancorp of Louisiana has net cash of US$8.9m. 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 Home Federal Bancorp of Louisiana’s P/E Ratio
Home Federal Bancorp of Louisiana has a P/E of 11.9. That’s below the average in the US market, which is 16.7. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic.
Investors have an opportunity when market expectations about a stock are wrong. 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.’ 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.
You might be able to find a better buy than Home Federal Bancorp of Louisiana. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 email@example.com.