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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Stock Yards Bancorp, Inc.'s (NASDAQ:SYBT) P/E ratio could help you assess the value on offer. Stock Yards Bancorp has a price to earnings ratio of 13.63, based on the last twelve months. That corresponds to an earnings yield of approximately 7.3%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Stock Yards Bancorp:
P/E of 13.63 = $34.78 ÷ $2.55 (Based on the trailing twelve months to March 2019.)
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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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.
Stock Yards Bancorp increased earnings per share by a whopping 42% last year. And its annual EPS growth rate over 5 years is 14%. So we'd generally expect it to have a relatively high P/E ratio.
How Does Stock Yards Bancorp's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Stock Yards Bancorp has a higher P/E than the average company (12.7) in the banks industry.
That means that the market expects Stock Yards Bancorp will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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.
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.
Stock Yards Bancorp's Balance Sheet
Stock Yards Bancorp has net cash of US$6.4m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On Stock Yards Bancorp's P/E Ratio
Stock Yards Bancorp trades on a P/E ratio of 13.6, which is below the US market average of 17.7. 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. 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.
You might be able to find a better buy than Stock Yards Bancorp. 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).
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.