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 First Business Financial Services, Inc.'s (NASDAQ:FBIZ) P/E ratio could help you assess the value on offer. First Business Financial Services has a P/E ratio of 9.94, based on the last twelve months. In other words, at today's prices, investors are paying $9.94 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for First Business Financial Services:
P/E of 9.94 = $24.59 ÷ $2.48 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does First Business Financial Services Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see First Business Financial Services has a lower P/E than the average (12.7) in the banks industry classification.
This suggests that market participants think First Business Financial Services will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
First Business Financial Services increased earnings per share by a whopping 33% last year. And its annual EPS growth rate over 5 years is 6.7%. With that performance, I would expect it to have an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
How Does First Business Financial Services's Debt Impact Its P/E Ratio?
First Business Financial Services's net debt is considerable, at 147% of its market cap. 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 First Business Financial Services's P/E Ratio
First Business Financial Services's P/E is 9.9 which is below average (18.5) in the US market. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than First Business Financial Services. 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).
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.
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