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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Spirit of Texas Bancshares, Inc.'s (NASDAQ:STXB) P/E ratio and reflect on what it tells us about the company's share price. Spirit of Texas Bancshares has a P/E ratio of 16.45, based on the last twelve months. In other words, at today's prices, investors are paying $16.45 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Spirit of Texas Bancshares:
P/E of 16.45 = $21 ÷ $1.28 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
Does Spirit of Texas Bancshares Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below, Spirit of Texas Bancshares has a higher P/E than the average company (12.2) in the banks industry.
That means that the market expects Spirit of Texas Bancshares will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's nice to see that Spirit of Texas Bancshares grew EPS by a stonking 36% in the last year. And earnings per share have improved by 21% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 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.
So What Does Spirit of Texas Bancshares's Balance Sheet Tell Us?
Spirit of Texas Bancshares has net cash of US$84m. This is fairly high at 25% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Spirit of Texas Bancshares's P/E Ratio
Spirit of Texas Bancshares has a P/E of 16.4. That's around the same as the average in the US market, which is 17.1. The excess cash it carries is the gravy on top its fast EPS growth. So at a glance we're a bit surprised that Spirit of Texas Bancshares does not have a higher P/E ratio. Because analysts are even expecting further profit growth, we would venture this stock is worth a closer look..
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Spirit of Texas Bancshares. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.