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Here's How P/E Ratios Can Help Us Understand Bank of Queensland Limited (ASX:BOQ)

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Bank of Queensland Limited's (ASX:BOQ) P/E ratio to inform your assessment of the investment opportunity. Bank of Queensland has a P/E ratio of 11.19, based on the last twelve months. That is equivalent to an earnings yield of about 8.9%.

See our latest analysis for Bank of Queensland

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Bank of Queensland:

P/E of 11.19 = A$8.93 ÷ A$0.80 (Based on the trailing twelve months to February 2019.)

Is A High P/E 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.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Bank of Queensland's earnings per share fell by 15% in the last twelve months. But it has grown its earnings per share by 3.4% per year over the last five years. And it has shrunk its earnings per share by 4.0% per year over the last three years. This might lead to low expectations.

Does Bank of Queensland Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Bank of Queensland has a lower P/E than the average (12.7) in the banks industry classification.

ASX:BOQ Price Estimation Relative to Market, May 14th 2019

This suggests that market participants think Bank of Queensland will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. 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.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Bank of Queensland's Balance Sheet

Bank of Queensland has net debt worth a very significant 268% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Verdict On Bank of Queensland's P/E Ratio

Bank of Queensland has a P/E of 11.2. That's below the average in the AU market, which is 16.1. 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. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Bank of Queensland. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 editorial-team@simplywallst.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.