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Why Banco de Sabadell, S.A.’s (BME:SAB) High P/E Ratio Isn’t Necessarily A Bad Thing

Seth Doty

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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 Banco de Sabadell, S.A.’s (BME:SAB) P/E ratio and reflect on what it tells us about the company’s share price. Banco de Sabadell has a price to earnings ratio of 15.09, based on the last twelve months. In other words, at today’s prices, investors are paying €15.09 for every €1 in prior year profit.

View our latest analysis for Banco de Sabadell

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 Banco de Sabadell:

P/E of 15.09 = €0.89 ÷ €0.059 (Based on the trailing twelve months to December 2018.)

Is A High P/E 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.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

Banco de Sabadell’s earnings per share fell by 58% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 6.4%. And it has shrunk its earnings per share by 21% per year over the last three years. This growth rate might warrant a low P/E ratio. This growth rate might warrant a low P/E ratio.

How Does Banco de Sabadell’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Banco de Sabadell has a higher P/E than the average company (10.6) in the banks industry.

BME:SAB PE PEG Gauge February 7th 19

Banco de Sabadell’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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.

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

The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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 Banco de Sabadell’s P/E?

Banco de Sabadell’s net debt is considerable, at 136% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.

The Bottom Line On Banco de Sabadell’s P/E Ratio

Banco de Sabadell trades on a P/E ratio of 15.1, which is below the ES market average of 17.8. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations.

Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold they key to an excellent investment decision.

You might be able to find a better buy than Banco de Sabadell. 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).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.