The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Sound Financial Bancorp, Inc.’s (NASDAQ:SFBC) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Sound Financial Bancorp’s P/E ratio is 12.86. That corresponds to an earnings yield of approximately 7.8%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Sound Financial Bancorp:
P/E of 12.86 = $33.9 ÷ $2.64 (Based on the year to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Most would be impressed by Sound Financial Bancorp earnings growth of 20% in the last year. And it has bolstered its earnings per share by 9.6% per year over the last five years. So one might expect an above average P/E ratio.
How Does Sound Financial Bancorp’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Sound Financial Bancorp has a lower P/E than the average (14.5) in the banks industry classification.
Its relatively low P/E ratio indicates that Sound Financial Bancorp shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Sound Financial Bancorp, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
How Does Sound Financial Bancorp’s Debt Impact Its P/E Ratio?
Sound Financial Bancorp’s net debt is 40% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On Sound Financial Bancorp’s P/E Ratio
Sound Financial Bancorp has a P/E of 12.9. That’s below the average in the US market, which is 16.4. 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. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.