The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use MutualFirst Financial Inc’s (NASDAQ:MFSF) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, MutualFirst Financial’s P/E ratio is 19.53. In other words, at today’s prices, investors are paying $19.53 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for MutualFirst Financial:
P/E of 19.53 = $36.28 ÷ $1.86 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. 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.
MutualFirst Financial’s earnings per share fell by 3.2% in the last twelve months. But EPS is up 8.9% over the last 5 years.
How Does MutualFirst Financial’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (15.6) for companies in the banks industry is lower than MutualFirst Financial’s P/E.
That means that the market expects MutualFirst Financial will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. 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
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does MutualFirst Financial’s Debt Impact Its P/E Ratio?
Net debt totals 80% of MutualFirst Financial’s market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Verdict On MutualFirst Financial’s P/E Ratio
MutualFirst Financial has a P/E of 19.5. That’s around the same as the average in the US market, which is 18.5. With relatively high debt, and no earnings per share growth over twelve months, the P/E suggests that many have an expectation that company will find some growth.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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.
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 firstname.lastname@example.org.