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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Eagle Bancorp, Inc.’s (NASDAQ:EGBN) P/E ratio and reflect on what it tells us about the company’s share price. Eagle Bancorp has a P/E ratio of 12.27, based on the last twelve months. That corresponds to an earnings yield of approximately 8.2%.
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 Eagle Bancorp:
P/E of 12.27 = $54.45 ÷ $4.44 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Eagle Bancorp grew EPS by a whopping 51% in the last year. And earnings per share have improved by 16% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Eagle 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 Eagle Bancorp has a P/E ratio that is roughly in line with the banks industry average (13.3).
Its P/E ratio suggests that Eagle Bancorp shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.
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. 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.
Eagle Bancorp’s Balance Sheet
The extra options and safety that comes with Eagle Bancorp’s US$74m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Eagle Bancorp’s P/E Ratio
Eagle Bancorp has a P/E of 12.3. That’s below the average in the US market, which is 16.8. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don’t believe the strong growth will continue.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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 email@example.com.