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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Stifel Financial Corp.'s (NYSE:SF) P/E ratio and reflect on what it tells us about the company's share price. Stifel Financial has a price to earnings ratio of 10.66, based on the last twelve months. That is equivalent to an earnings yield of about 9.4%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Stifel Financial:
P/E of 10.66 = $58.7 ÷ $5.51 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Stifel Financial's earnings made like a rocket, taking off 94% last year. Even better, EPS is up 70% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
Does Stifel Financial Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Stifel Financial has a lower P/E than the average (32) in the capital markets industry classification.
Stifel Financial's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Stifel Financial's P/E?
With net cash of US$1.8b, Stifel Financial has a very strong balance sheet, which may be important for its business. Having said that, at 44% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Stifel Financial's P/E Ratio
Stifel Financial trades on a P/E ratio of 10.7, which is below the US market average of 18.1. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Given analysts are expecting further growth, one I would have expected a higher P/E ratio. So this stock may well be worth further research.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Stifel Financial may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 email@example.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.