The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Westamerica Bancorporation’s (NASDAQ:WABC) P/E ratio could help you assess the value on offer. Westamerica Bancorporation has a price to earnings ratio of 22.77, based on the last twelve months. That means that at current prices, buyers pay $22.77 for every $1 in trailing yearly profits.
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 Westamerica Bancorporation:
P/E of 22.77 = $61.15 ÷ $2.69 (Based on the year to December 2018.)
Is A High Price-to-Earnings 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
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
It’s nice to see that Westamerica Bancorporation grew EPS by a stonking 41% in the last year. Unfortunately, earnings per share are down 1.9% a year, over 5 years.
How Does Westamerica Bancorporation’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Westamerica Bancorporation has a higher P/E than the average (13.2) P/E for companies in the banks industry.
That means that the market expects Westamerica Bancorporation will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Is Debt Impacting Westamerica Bancorporation’s P/E?
Since Westamerica Bancorporation holds net cash of US$369m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Westamerica Bancorporation’s P/E Ratio
Westamerica Bancorporation trades on a P/E ratio of 22.8, which is above the US market average of 17.4. With cash in the bank the company has plenty of growth options — and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company
Investors have an opportunity when market expectations about a stock are wrong. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Westamerica Bancorporation. 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).
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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.