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Is TFS Financial Corporation's (NASDAQ:TFSL) High P/E Ratio A Problem For Investors?

Simply Wall St

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at TFS Financial Corporation's (NASDAQ:TFSL) P/E ratio and reflect on what it tells us about the company's share price. TFS Financial has a P/E ratio of 59.1, based on the last twelve months. That corresponds to an earnings yield of approximately 1.7%.

See our latest analysis for TFS Financial

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for TFS Financial:

P/E of 59.1 = $17.54 ÷ $0.30 (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 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.

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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

TFS Financial shrunk earnings per share by 6.6% last year. But it has grown its earnings per share by 6.9% per year over the last five years.

Does TFS Financial 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, TFS Financial has a much higher P/E than the average company (14) in the mortgage industry.

NasdaqGS:TFSL Price Estimation Relative to Market, June 27th 2019

Its relatively high P/E ratio indicates that TFS 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 always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. 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 TFS Financial's Debt Impact Its P/E Ratio?

TFS Financial has net debt worth 70% of its market capitalization. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Bottom Line On TFS Financial's P/E Ratio

TFS Financial's P/E is 59.1 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 TFS Financial. 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 editorial-team@simplywallst.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.