The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use First Commonwealth Financial Corporation’s (NYSE:FCF) P/E ratio to inform your assessment of the investment opportunity. First Commonwealth Financial has a P/E ratio of 15.56, based on the last twelve months. That is equivalent to an earnings yield of about 6.4%.
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How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for First Commonwealth Financial:
P/E of 15.56 = $13.34 ÷ $0.86 (Based on the trailing twelve months to September 2018.)
Is A High P/E 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
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. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
First Commonwealth Financial increased earnings per share by an impressive 16% over the last twelve months. And earnings per share have improved by 12% annually, over the last five years. With that performance, you might expect an above average P/E ratio.
How Does First Commonwealth Financial’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (13.7) for companies in the banks industry is lower than First Commonwealth Financial’s P/E.
Its relatively high P/E ratio indicates that First Commonwealth Financial shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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 First Commonwealth Financial’s P/E?
First Commonwealth Financial has net debt worth 51% of its market capitalization. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On First Commonwealth Financial’s P/E Ratio
First Commonwealth Financial has a P/E of 15.6. That’s around the same as the average in the US market, which is 16.7. The significant levels of debt do detract somewhat from the strong earnings growth. However, the P/E ratio implies that most doubt the strong growth will continue.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.