The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at United Community Financial Corp.’s (NASDAQ:UCFC) P/E ratio and reflect on what it tells us about the company’s share price. United Community Financial has a price to earnings ratio of 12.06, based on the last twelve months. In other words, at today’s prices, investors are paying $12.06 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for United Community Financial:
P/E of 12.06 = $9 ÷ $0.75 (Based on the trailing twelve months to December 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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
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 unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
United Community Financial increased earnings per share by a whopping 69% last year. And earnings per share have improved by 27% annually, over the last three years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does United Community Financial’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see United Community Financial has a lower P/E than the average (17) in the mortgage industry classification.
Its relatively low P/E ratio indicates that United Community Financial shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with United Community 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.
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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does United Community Financial’s Debt Impact Its P/E Ratio?
United Community Financial’s net debt is 40% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On United Community Financial’s P/E Ratio
United Community Financial trades on a P/E ratio of 12.1, which is below the US market average of 16.9. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors should be looking to buy stocks that the market is wrong about. 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.’ 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 United Community Financial. 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).
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 email@example.com.