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Is Riverview Financial Corporation's (NASDAQ:RIVE) High P/E Ratio A Problem For Investors?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Riverview Financial Corporation's (NASDAQ:RIVE) P/E ratio to inform your assessment of the investment opportunity. What is Riverview Financial's P/E ratio? Well, based on the last twelve months it is 17.92. That means that at current prices, buyers pay $17.92 for every $1 in trailing yearly profits.

Check out our latest analysis for Riverview Financial

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 Riverview Financial:

P/E of 17.92 = $11.79 ÷ $0.66 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Riverview Financial's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Riverview Financial has a higher P/E than the average company (12.4) in the banks industry.

NasdaqGM:RIVE Price Estimation Relative to Market, October 10th 2019

That means that the market expects Riverview Financial will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Riverview Financial's 391% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 2.2%. Regrettably, the longer term performance is poor, with EPS down 4.5% per year over 5 years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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.

How Does Riverview Financial's Debt Impact Its P/E Ratio?

Riverview Financial has net cash of US$34m. This is fairly high at 31% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Riverview Financial's P/E Ratio

Riverview Financial trades on a P/E ratio of 17.9, which is fairly close to the US market average of 17.3. Its net cash position is the cherry on top of its superb EPS growth. So at a glance we're a bit surprised that Riverview Financial does not have a higher P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts you might want to assess this data-rich visualization 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.

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 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. Thank you for reading.