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

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to TFS Financial Corporation's (NASDAQ:TFSL), to help you decide if the stock is worth further research. TFS Financial has a price to earnings ratio of 68.61, based on the last twelve months. That is equivalent to an earnings yield of about 1.5%.

Check out our latest analysis for TFS Financial

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 TFS Financial:

P/E of 68.61 = USD19.61 ÷ USD0.29 (Based on the year to September 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

Does TFS Financial 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. As you can see below, TFS Financial has a much higher P/E than the average company (14.2) in the mortgage industry.

NasdaqGS:TFSL Price Estimation Relative to Market, January 16th 2020

Its relatively high P/E ratio indicates that TFS Financial shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

TFS Financial's earnings per share fell by 6.4% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 5.5%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 TFS Financial's P/E?

Net debt totals 68% of TFS Financial's market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Verdict On TFS Financial's P/E Ratio

TFS Financial's P/E is 68.6 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.

Investors should be looking to buy stocks that the market is wrong about. 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 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.

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.

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. Thank you for reading.