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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 Arrow Financial Corporation's (NASDAQ:AROW) P/E ratio and reflect on what it tells us about the company's share price. Arrow Financial has a price to earnings ratio of 13.34, based on the last twelve months. In other words, at today's prices, investors are paying $13.34 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Arrow Financial:
P/E of 13.34 = $33.7 ÷ $2.53 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Arrow Financial's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Arrow Financial has a P/E ratio that is roughly in line with the banks industry average (12.8).
That indicates that the market expects Arrow Financial will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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.
Most would be impressed by Arrow Financial earnings growth of 16% in the last year. And its annual EPS growth rate over 5 years is 10%. So one might expect an above average P/E ratio.
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.
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 Arrow Financial's P/E?
Arrow Financial has net debt equal to 27% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Arrow Financial's P/E Ratio
Arrow Financial has a P/E of 13.3. That's below the average in the US market, which is 18. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors should be looking to buy stocks that the market is wrong about. 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.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Arrow Financial. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.