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 Malvern Bancorp, Inc.’s (NASDAQ:MLVF) P/E ratio could help you assess the value on offer. Malvern Bancorp has a price to earnings ratio of 17.24, based on the last twelve months. In other words, at today’s prices, investors are paying $17.24 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 Malvern Bancorp:
P/E of 17.24 = $19.51 ÷ $1.13 (Based on the year to September 2018.)
Is A High P/E 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Malvern Bancorp increased earnings per share by a whopping 25% last year. And it has bolstered its earnings per share by 61% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Malvern Bancorp’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below Malvern Bancorp has a P/E ratio that is fairly close for the average for the mortgage industry, which is 16.1.
Its P/E ratio suggests that Malvern Bancorp shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Malvern Bancorp actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. 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.
Is Debt Impacting Malvern Bancorp’s P/E?
Malvern Bancorp’s net debt is 76% of its 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 Malvern Bancorp’s P/E Ratio
Malvern Bancorp trades on a P/E ratio of 17.2, which is fairly close to the US market average of 16.7. The significant levels of debt do detract somewhat from the strong earnings growth. The P/E suggests the market isn’t confident that growth will be sustained, though.
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.’ Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.
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.