Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Evans Bancorp, Inc.'s (NYSEMKT:EVBN) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Evans Bancorp's P/E ratio is 10.67. In other words, at today's prices, investors are paying $10.67 for every $1 in prior year profit.
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 Evans Bancorp:
P/E of 10.67 = USD38.42 ÷ USD3.60 (Based on the trailing twelve months to December 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Evans Bancorp Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (12.5) for companies in the banks industry is higher than Evans Bancorp's P/E.
Its relatively low P/E ratio indicates that Evans Bancorp shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Evans Bancorp's earnings per share grew by -6.0% in the last twelve months. And its annual EPS growth rate over 5 years is 13%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Evans Bancorp's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Evans Bancorp's US$11m 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 Evans Bancorp's P/E Ratio
Evans Bancorp trades on a P/E ratio of 10.7, which is below the US market average of 18.2. Recent earnings growth wasn't bad. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations.
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: Evans 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).
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.
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. Thank you for reading.