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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 Lake Shore Bancorp, Inc.'s (NASDAQ:LSBK) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Lake Shore Bancorp's P/E ratio is 22.92. That is equivalent to an earnings yield of about 4.4%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Lake Shore Bancorp:
P/E of 22.92 = $14.98 ÷ $0.65 (Based on the trailing twelve months to March 2019.)
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 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.
Does Lake Shore Bancorp 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 Lake Shore Bancorp has a higher P/E than the average (14.4) P/E for companies in the mortgage industry.
Its relatively high P/E ratio indicates that Lake Shore Bancorp 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Lake Shore Bancorp increased earnings per share by an impressive 11% over the last twelve months. Unfortunately, earnings per share are down 6.5% a year, over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Is Debt Impacting Lake Shore Bancorp's P/E?
Since Lake Shore Bancorp holds net cash of US$5.7m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Lake Shore Bancorp's P/E Ratio
Lake Shore Bancorp's P/E is 22.9 which is above average (18) in its market. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it does not seem strange that the P/E is above average.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Lake Shore Bancorp may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.