This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Northrim BanCorp, Inc.’s (NASDAQ:NRIM) P/E ratio could help you assess the value on offer. What is Northrim BanCorp’s P/E ratio? Well, based on the last twelve months it is 12.15. That corresponds to an earnings yield of approximately 8.2%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Northrim BanCorp:
P/E of 12.15 = $37.48 ÷ $3.09 (Based on the trailing twelve months to September 2019.)
Is A High P/E 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 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 Northrim BanCorp Have A Relatively High Or Low P/E For Its Industry?
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 (13.0) for companies in the banks industry is roughly the same as Northrim BanCorp’s P/E.
That indicates that the market expects Northrim BanCorp will perform roughly in line with other companies in its industry. So if Northrim BanCorp actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that Northrim BanCorp grew EPS by a stonking 38% in the last year. And it has bolstered its earnings per share by 9.0% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
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. So it won’t reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting Northrim BanCorp’s P/E?
Northrim BanCorp has net cash of US$70m. This is fairly high at 29% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Northrim BanCorp’s P/E Ratio
Northrim BanCorp has a P/E of 12.1. That’s below the average in the US market, which is 18.9. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic.
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. Although we don’t have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Northrim 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).
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.
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