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 TowneBank’s (NASDAQ:TOWN) P/E ratio to inform your assessment of the investment opportunity. TowneBank has a price to earnings ratio of 15.02, based on the last twelve months. That corresponds to an earnings yield of approximately 6.7%.
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 TowneBank:
P/E of 15.02 = $24.07 ÷ $1.6 (Based on the year to September 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 isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. 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.
TowneBank’s earnings per share grew by -5.5% in the last twelve months. And it has bolstered its earnings per share by 5.8% per year over the last five years.
How Does TowneBank’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below TowneBank has a P/E ratio that is fairly close for the average for the banks industry, which is 14.1.
That indicates that the market expects TowneBank will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
TowneBank’s Balance Sheet
TowneBank has net debt worth 26% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On TowneBank’s P/E Ratio
TowneBank trades on a P/E ratio of 15, which is fairly close to the US market average of 16. When you consider the modest EPS growth last year (along with some debt), it seems the market thinks the growth is sustainable.
Investors should be looking to buy stocks that the market is wrong about. 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 TowneBank. 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 email@example.com.