Why Arrow Financial Corporation's (NASDAQ:AROW) High P/E Ratio Isn't Necessarily A Bad Thing
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Arrow Financial Corporation's (NASDAQ:AROW), to help you decide if the stock is worth further research. Based on the last twelve months, Arrow Financial's P/E ratio is 11.47. That means that at current prices, buyers pay $11.47 for every $1 in trailing yearly profits.
Check out our latest analysis for Arrow Financial
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Arrow Financial:
P/E of 11.47 = $28.770 ÷ $2.508 (Based on the trailing twelve months to December 2019.)
(Note: the above calculation results may not be precise due to rounding.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Arrow Financial Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Arrow Financial has a higher P/E than the average (9.2) P/E for companies in the banks industry.
Its relatively high P/E ratio indicates that Arrow Financial shareholders think it will perform better than other companies in its industry classification. 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Arrow Financial saw earnings per share improve by 2.6% last year. And its annual EPS growth rate over 5 years is 9.2%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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).
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.
Arrow Financial's Balance Sheet
Arrow Financial's net debt equates to 46% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Arrow Financial's P/E Ratio
Arrow Financial trades on a P/E ratio of 11.5, which is below the US market average of 14.0. The company does have a little debt, and EPS is moving in the right direction. The P/E ratio implies the market is cautious about longer term prospects.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
