This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Horizon Bancorp, Inc.’s (NASDAQ:HBNC) P/E ratio could help you assess the value on offer. Horizon Bancorp has a P/E ratio of 12.51, based on the last twelve months. That corresponds to an earnings yield of approximately 8.0%.
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 Horizon Bancorp:
P/E of 12.51 = $15.6 ÷ $1.25 (Based on the trailing twelve months 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. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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.
Horizon Bancorp increased earnings per share by a whopping 34% last year. And it has bolstered its earnings per share by 2.6% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Horizon Bancorp’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Horizon Bancorp has a lower P/E than the average (14.1) P/E for companies in the banks industry.
This suggests that market participants think Horizon Bancorp will underperform other companies in its industry. Since the market seems unimpressed with Horizon Bancorp, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.
Is Debt Impacting Horizon Bancorp’s P/E?
Net debt totals 74% of Horizon Bancorp’s market cap. 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 Bottom Line On Horizon Bancorp’s P/E Ratio
Horizon Bancorp trades on a P/E ratio of 12.5, which is below the US market average of 16. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 they key to an excellent investment decision.
But note: Horizon 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 email@example.com.