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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Dime Community Bancshares, Inc.'s (NASDAQ:DCOM) P/E ratio could help you assess the value on offer. Dime Community Bancshares has a P/E ratio of 14.38, based on the last twelve months. In other words, at today's prices, investors are paying $14.38 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 Dime Community Bancshares:
P/E of 14.38 = $18.79 ÷ $1.31 (Based on the trailing twelve months 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. 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
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Dime Community Bancshares saw earnings per share decrease by 12% last year. But EPS is up 1.6% over the last 5 years. And it has shrunk its earnings per share by 17% per year over the last three years. This could justify a low P/E.
How Does Dime Community Bancshares's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below Dime Community Bancshares has a P/E ratio that is fairly close for the average for the mortgage industry, which is 14.
Dime Community Bancshares's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Dime Community Bancshares actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Dime Community Bancshares's Balance Sheet
Net debt totals a substantial 162% of Dime Community Bancshares's market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Bottom Line On Dime Community Bancshares's P/E Ratio
Dime Community Bancshares's P/E is 14.4 which is below average (17.5) in the US market. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 Dime Community Bancshares. 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.