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Read This Before You Buy Magyar Bancorp, Inc. (NASDAQ:MGYR) Because Of Its P/E Ratio

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Magyar Bancorp (NASDAQ:MGYR) shares have retraced a considerable in the last month, but the stock is still up slightly on where it started the quarter. The bad news is that the recent drop obliterated the last year's worth of gains; the stock is flat over 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

View our latest analysis for Magyar Bancorp

Does Magyar Bancorp Have A Relatively High Or Low P/E For Its Industry?

Magyar Bancorp's P/E of 23.90 indicates some degree of optimism towards the stock. The image below shows that Magyar Bancorp has a higher P/E than the average (14.5) P/E for companies in the mortgage industry.

NasdaqGM:MGYR Price Estimation Relative to Market, January 2nd 2020
NasdaqGM:MGYR Price Estimation Relative to Market, January 2nd 2020

Magyar Bancorp's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Notably, Magyar Bancorp grew EPS by a whopping 48% in the last year. And its annual EPS growth rate over 5 years is 39%. So we'd generally expect it to have a relatively high P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

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

Net debt totals 21% of Magyar Bancorp's market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.

The Verdict On Magyar Bancorp's P/E Ratio

Magyar Bancorp has a P/E of 23.9. That's higher than the average in its market, which is 18.9. While the company does use modest debt, its recent earnings growth is superb. So to be frank we are not surprised it has a high P/E ratio. What can be absolutely certain is that the market has become less optimistic about Magyar Bancorp over the last month, with the P/E ratio falling from 23.9 back then to 23.9 today. 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 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 shareholders might want to examine this 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.

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.