This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how First United Corporation’s (NASDAQ:FUNC) P/E ratio could help you assess the value on offer. First United has a P/E ratio of 19.67, based on the last twelve months. That is equivalent to an earnings yield of about 5.1%.
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 First United:
P/E of 19.67 = $19.55 ÷ $0.99 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
First United increased earnings per share by 6.5% last year. And its annual EPS growth rate over 5 years is 7.2%. In contrast, EPS has decreased by 22%, annually, over 3 years.
How Does First United’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, First United has a higher P/E than the average company (15.6) in the banks industry.
Its relatively high P/E ratio indicates that First United shareholders think it will perform better than other companies in its industry classification. 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.
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. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Is Debt Impacting First United’s P/E?
First United has net debt worth 89% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On First United’s P/E Ratio
First United’s P/E is 19.7 which is above average (18.2) in the US market. With relatively high debt, and reasonably modest earnings per share growth over twelve months, it’s safe to say the market believes the company will improve its growth in the future.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: First United 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).
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 firstname.lastname@example.org.