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 Fifth Third Bancorp's (NASDAQ:FITB) P/E ratio could help you assess the value on offer. Based on the last twelve months, Fifth Third Bancorp's P/E ratio is 8.85. In other words, at today's prices, investors are paying $8.85 for every $1 in prior year profit.
How Do I Calculate Fifth Third Bancorp's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Fifth Third Bancorp:
P/E of 8.85 = $26.31 ÷ $2.97 (Based on the trailing twelve months to June 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Fifth Third Bancorp Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (12.2) for companies in the banks industry is higher than Fifth Third Bancorp's P/E.
Its relatively low P/E ratio indicates that Fifth Third Bancorp shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Fifth Third Bancorp, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Fifth Third Bancorp shrunk earnings per share by 23% over the last year. But over the longer term (5 years) earnings per share have increased by 11%.
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. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Fifth Third Bancorp's Debt Impact Its P/E Ratio?
Fifth Third Bancorp's net debt is 70% of its market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Fifth Third Bancorp's P/E Ratio
Fifth Third Bancorp has a P/E of 8.9. That's below the average in the US market, which is 17.3. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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: Fifth Third 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).
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 email@example.com. 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.