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 Sachem Capital Corp.'s (NYSEMKT:SACH) P/E ratio could help you assess the value on offer. What is Sachem Capital's P/E ratio? Well, based on the last twelve months it is 10.98. That is equivalent to an earnings yield of about 9.1%.
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 Sachem Capital:
P/E of 10.98 = $4.43 ÷ $0.40 (Based on the year to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company 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 Does Sachem Capital's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Sachem Capital has a lower P/E than the average (14.3) P/E for companies in the mortgage industry.
Sachem Capital's P/E tells us that market participants think it will not fare as well as its peers in the same 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Sachem Capital shrunk earnings per share by 19% over the last year. But over the longer term (3 years), earnings per share have increased by 6.0%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Sachem Capital's Balance Sheet
Sachem Capital's net debt is 13% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Sachem Capital's P/E Ratio
Sachem Capital has a P/E of 11.0. That's below the average in the US market, which is 18.9. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Sachem Capital 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).
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.
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. Thank you for reading.