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Here's How P/E Ratios Can Help Us Understand Raymond James Financial, Inc. (NYSE:RJF)

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Raymond James Financial, Inc.'s (NYSE:RJF) P/E ratio to inform your assessment of the investment opportunity. Raymond James Financial has a price to earnings ratio of 12.22, based on the last twelve months. In other words, at today's prices, investors are paying $12.22 for every $1 in prior year profit.

See our latest analysis for Raymond James Financial

How Do You Calculate Raymond James Financial's P/E Ratio?

The formula for price to earnings is:

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

Or for Raymond James Financial:

P/E of 12.22 = $85.18 ÷ $6.97 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's nice to see that Raymond James Financial grew EPS by a stonking 37% in the last year. And its annual EPS growth rate over 5 years is 18%. So we'd generally expect it to have a relatively high P/E ratio.

Does Raymond James Financial Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Raymond James Financial has a lower P/E than the average (34.4) P/E for companies in the capital markets industry.

NYSE:RJF Price Estimation Relative to Market, May 30th 2019

Its relatively low P/E ratio indicates that Raymond James Financial shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

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. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

So What Does Raymond James Financial's Balance Sheet Tell Us?

Raymond James Financial has net cash of US$4.2b. This is fairly high at 35% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Raymond James Financial's P/E Ratio

Raymond James Financial has a P/E of 12.2. That's below the average in the US market, which is 17.3. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic.

Investors have an opportunity when market expectations about a stock are wrong. 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.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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 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.