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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Southern First Bancshares, Inc.'s (NASDAQ:SFST) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Southern First Bancshares has a P/E ratio of 12.09. In other words, at today's prices, investors are paying $12.09 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Southern First Bancshares:
P/E of 12.09 = $37.65 ÷ $3.11 (Based on the trailing twelve months to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Notably, Southern First Bancshares grew EPS by a whopping 49% in the last year. And its annual EPS growth rate over 5 years is 24%. I'd therefore be a little surprised if its P/E ratio was not relatively high.
How Does Southern First Bancshares's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (13.1) for companies in the banks industry is higher than Southern First Bancshares's P/E.
Southern First Bancshares's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Southern First Bancshares's Balance Sheet Tell Us?
With net cash of US$64m, Southern First Bancshares has a very strong balance sheet, which may be important for its business. Having said that, at 23% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Southern First Bancshares's P/E Ratio
Southern First Bancshares has a P/E of 12.1. That's below the average in the US market, which is 18.4. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Southern First Bancshares. 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).
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.
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. Thank you for reading.