The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Plumas Bancorp's (NASDAQ:PLBC) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Plumas Bancorp has a P/E ratio of 8.95. That is equivalent to an earnings yield of about 11.2%.
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 Plumas Bancorp:
P/E of 8.95 = USD26.42 ÷ USD2.95 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each USD1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Plumas Bancorp'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 Plumas Bancorp has a lower P/E than the average (12.7) in the banks industry classification.
Plumas Bancorp's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Plumas Bancorp, 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.
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.
Notably, Plumas Bancorp grew EPS by a whopping 30% in the last year. And its annual EPS growth rate over 5 years is 27%. With that performance, I would expect it to have an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.
Is Debt Impacting Plumas Bancorp's P/E?
Plumas Bancorp has net cash of US$3.7m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Plumas Bancorp's P/E Ratio
Plumas Bancorp trades on a P/E ratio of 8.9, which is below the US market average of 18.9. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.