The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Australia and New Zealand Banking Group Limited's (ASX:ANZ) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Australia and New Zealand Banking Group's P/E ratio is 11.82. That is equivalent to an earnings yield of about 8.5%.
How Do You Calculate Australia and New Zealand Banking Group's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Australia and New Zealand Banking Group:
P/E of 11.82 = A$26.25 ÷ A$2.22 (Based on the trailing twelve months to September 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 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.
Does Australia and New Zealand Banking Group 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. As you can see below Australia and New Zealand Banking Group has a P/E ratio that is fairly close for the average for the banks industry, which is 11.8.
Australia and New Zealand Banking Group's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Australia and New Zealand Banking Group's earnings per share fell by 9.6% in the last twelve months. But EPS is up 4.0% over the last 3 years. And over the longer term (5 years) earnings per share have decreased 3.6% annually. So we might expect a relatively low P/E.
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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.
How Does Australia and New Zealand Banking Group's Debt Impact Its P/E Ratio?
Australia and New Zealand Banking Group's net debt is 23% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Australia and New Zealand Banking Group's P/E Ratio
Australia and New Zealand Banking Group's P/E is 11.8 which is below average (18.7) in the AU market. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Australia and New Zealand Banking Group 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 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.