This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how First Community Bankshares, Inc.'s (NASDAQ:FCBC) P/E ratio could help you assess the value on offer. First Community Bankshares has a price to earnings ratio of 15.78, based on the last twelve months. That is equivalent to an earnings yield of about 6.3%.
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 First Community Bankshares:
P/E of 15.78 = $34.58 ÷ $2.19 (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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
First Community Bankshares's earnings made like a rocket, taking off 73% last year. Even better, EPS is up 18% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
Does First Community Bankshares Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, First Community Bankshares has a higher P/E than the average company (13) in the banks industry.
First Community Bankshares's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. 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 investing in growth. That means taking on debt (or spending its cash).
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.
So What Does First Community Bankshares's Balance Sheet Tell Us?
Since First Community Bankshares holds net cash of US$48m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On First Community Bankshares's P/E Ratio
First Community Bankshares has a P/E of 15.8. That's below the average in the US market, which is 18.3. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than First Community Bankshares. 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.