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 Prudential Bancorp, Inc.’s (NASDAQ:PBIP) P/E ratio could help you assess the value on offer. Prudential Bancorp has a P/E ratio of 17.81, based on the last twelve months. In other words, at today’s prices, investors are paying $17.81 for every $1 in prior year profit.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Prudential Bancorp:
P/E of 17.81 = $18.15 ÷ $1.02 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company 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.’
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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that Prudential Bancorp grew EPS by a stonking 326% in the last year. And it has bolstered its earnings per share by 30% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Prudential Bancorp’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (17) for companies in the mortgage industry is roughly the same as Prudential Bancorp’s P/E.
That indicates that the market expects Prudential Bancorp will perform roughly in line with other companies in its industry. So if Prudential Bancorp actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
How Does Prudential Bancorp’s Debt Impact Its P/E Ratio?
Net debt totals a substantial 129% of Prudential Bancorp’s market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Verdict On Prudential Bancorp’s P/E Ratio
Prudential Bancorp’s P/E is 17.8 which is about average (17.1) in the US market. While it does have meaningful debt levels, it has also produced strong earnings growth recently. However, the P/E ratio implies that most doubt the strong growth will continue.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. 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 be able to find a better stock than Prudential Bancorp. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.