This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Franklin Financial Network, Inc.’s (NYSE:FSB) P/E ratio and reflect on what it tells us about the company’s share price. Franklin Financial Network has a price to earnings ratio of 13.35, based on the last twelve months. That is equivalent to an earnings yield of about 7.5%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Franklin Financial Network:
P/E of 13.35 = $32.87 ÷ $2.46 (Based on the year 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. 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Franklin Financial Network increased earnings per share by an impressive 15% over the last twelve months. And its annual EPS growth rate over 5 years is 17%. With that performance, you might expect an above average P/E ratio.
How Does Franklin Financial Network’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (13.5) for companies in the banks industry is roughly the same as Franklin Financial Network’s P/E.
Its P/E ratio suggests that Franklin Financial Network shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Franklin Financial Network actually outperforms its peers going forward, that should be a positive for the share price. 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
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).
Franklin Financial Network’s Balance Sheet
Franklin Financial Network’s net debt is 30% 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 Bottom Line On Franklin Financial Network’s P/E Ratio
Franklin Financial Network has a P/E of 13.4. That’s below the average in the US market, which is 17.6. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.
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.’ So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Franklin Financial Network 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).
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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.