Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Riverview Bancorp, Inc.'s (NASDAQ:RVSB) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Riverview Bancorp has a P/E ratio of 10.04. That means that at current prices, buyers pay $10.04 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Riverview Bancorp:
P/E of 10.04 = $7.56 ÷ $0.75 (Based on the year 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 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.
Does Riverview Bancorp 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. We can see in the image below that the average P/E (14.8) for companies in the mortgage industry is higher than Riverview Bancorp's P/E.
This suggests that market participants think Riverview Bancorp will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It's nice to see that Riverview Bancorp grew EPS by a stonking 41% in the last year. And its annual EPS growth rate over 3 years is 38%. So we'd generally expect it to have a relatively high P/E ratio. Unfortunately, earnings per share are down 1.9% a year, over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
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).
How Does Riverview Bancorp's Debt Impact Its P/E Ratio?
Riverview Bancorp has net debt equal to 34% of its market cap. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On Riverview Bancorp's P/E Ratio
Riverview Bancorp's P/E is 10 which is below average (18.2) in the US market. 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.
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 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.