This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Enterprise Bancorp Inc’s (NASDAQ:EBTC) P/E ratio and reflect on what it tells us about the company’s share price. Enterprise Bancorp has a price to earnings ratio of 14.87, based on the last twelve months. That means that at current prices, buyers pay $14.87 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Enterprise Bancorp:
P/E of 14.87 = $32.02 ÷ $2.15 (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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Most would be impressed by Enterprise Bancorp earnings growth of 15% in the last year. And its annual EPS growth rate over 5 years is 8.3%. With that performance, you might expect an above average P/E ratio.
How Does Enterprise Bancorp’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Enterprise Bancorp has a P/E ratio that is fairly close for the average for the banks industry, which is 15.3.
That indicates that the market expects Enterprise Bancorp will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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 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.
Enterprise Bancorp’s Balance Sheet
The extra options and safety that comes with Enterprise Bancorp’s US$51m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Enterprise Bancorp’s P/E Ratio
Enterprise Bancorp trades on a P/E ratio of 14.9, which is below the US market average of 17.5. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. 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. 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 might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Enterprise Bancorp. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.