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Do You Know What Power Financial Corporation's (TSE:PWF) P/E Ratio Means?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Power Financial Corporation's (TSE:PWF) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Power Financial has a P/E ratio of 10.25. In other words, at today's prices, investors are paying CA$10.25 for every CA$1 in prior year profit.

See our latest analysis for Power Financial

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

The formula for P/E is:

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

Or for Power Financial:

P/E of 10.25 = CA$28.85 ÷ CA$2.81 (Based on the trailing twelve months to June 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. 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.'

Does Power 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. If you look at the image below, you can see Power Financial has a lower P/E than the average (12.2) in the insurance industry classification.

TSX:PWF Price Estimation Relative to Market, September 9th 2019

This suggests that market participants think Power Financial will underperform other companies in its industry. Since the market seems unimpressed with Power Financial, it's quite possible it could surprise on the upside. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Power Financial increased earnings per share by 3.9% last year. And earnings per share have improved by 1.9% annually, over the last three years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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.

Power Financial's Balance Sheet

Power Financial has net debt equal to 50% of its market cap. While it's worth keeping this in mind, it isn't a worry.

The Bottom Line On Power Financial's P/E Ratio

Power Financial's P/E is 10.3 which is below average (13.8) in the CA market. EPS grew over the last twelve months, and debt levels are quite reasonable. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value.

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.

Of course you might be able to find a better stock than Power Financial. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.