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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Independent Bank Corporation's (NASDAQ:IBCP) P/E ratio could help you assess the value on offer. What is Independent Bank's P/E ratio? Well, based on the last twelve months it is 13.14. That is equivalent to an earnings yield of about 7.6%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Independent Bank:
P/E of 13.14 = $21.97 ÷ $1.67 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, Independent Bank grew EPS like Taylor Swift grew her fan base back in 2010; the 51% gain was both fast and well deserved. Even better, EPS is up 23% per year over three years. So you might say it really deserves to have an above-average P/E ratio. Unfortunately, earnings per share are down 18% a year, over 5 years.
Does Independent Bank Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Independent Bank has a P/E ratio that is roughly in line with the banks industry average (12.7).
That indicates that the market expects Independent Bank will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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 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.
Independent Bank's Balance Sheet
The extra options and safety that comes with Independent Bank's US$9.5m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Independent Bank's P/E Ratio
Independent Bank has a P/E of 13.1. That's below the average in the US market, which is 17.7. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 be able to find a better stock than Independent Bank. 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 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.