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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Independent Bank Corp.'s (NASDAQ:INDB) P/E ratio to inform your assessment of the investment opportunity. Independent Bank has a price to earnings ratio of 15.35, based on the last twelve months. That corresponds to an earnings yield of approximately 6.5%.
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 Independent Bank:
P/E of 15.35 = $71.53 ÷ $4.66 (Based on the trailing twelve months to March 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Independent Bank increased earnings per share by a whopping 36% last year. And it has bolstered its earnings per share by 16% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Does Independent Bank Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Independent Bank has a higher P/E than the average (12.7) P/E for companies in the banks industry.
Independent Bank's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors 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
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Independent Bank's Debt Impact Its P/E Ratio?
Net debt totals just 0.3% of Independent Bank's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Independent Bank's P/E Ratio
Independent Bank's P/E is 15.4 which is below average (17.7) in the US market. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
Investors should be looking to buy stocks that the market is wrong about. 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.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Independent Bank 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.