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Is Ottawa Bancorp, Inc.'s (NASDAQ:OTTW) P/E Ratio Really That Good?

Simply Wall St

Of late the Ottawa Bancorp (NASDAQ:OTTW) share price has softened like an ice cream in the sun, melting a full . But there's still good reason for shareholders to be content; the stock has gained 9.1% in the last 90 days. Indeed, the recent drop has reduced the annual gain to a relatively sedate 7.7% over the last twelve months.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So some would prefer to hold off buying when there is a lot of optimism towards a stock. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

Check out our latest analysis for Ottawa Bancorp

How Does Ottawa Bancorp's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 22.68 that there is some investor optimism about Ottawa Bancorp. The image below shows that Ottawa Bancorp has a higher P/E than the average (14.6) P/E for companies in the mortgage industry.

NasdaqCM:OTTW Price Estimation Relative to Market, December 21st 2019

Ottawa Bancorp's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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.

Ottawa Bancorp's 109% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 11%.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Ottawa Bancorp's Balance Sheet Tell Us?

Ottawa Bancorp has net cash of US$8.3m. This is fairly high at 20% 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 Ottawa Bancorp's P/E Ratio

Ottawa Bancorp's P/E is 22.7 which is above average (18.9) in its market. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Ottawa Bancorp to have a high P/E ratio. Given Ottawa Bancorp's P/E ratio has declined from 22.7 to 22.7 in the last month, we know for sure that the market is less confident about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

But note: Ottawa Bancorp 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 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.

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.