The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Southern First Bancshares, Inc.’s (NASDAQ:SFST) P/E ratio and reflect on what it tells us about the company’s share price. Southern First Bancshares has a price to earnings ratio of 11.83, based on the last twelve months. In other words, at today’s prices, investors are paying $11.83 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 = Share Price ÷ Earnings per Share (EPS)
Or for Southern First Bancshares:
P/E of 11.83 = USD41.80 ÷ USD3.53 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each USD1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Southern First Bancshares Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Southern First Bancshares has a lower P/E than the average (12.8) in the banks industry classification.
Southern First Bancshares’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Southern First Bancshares, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. 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.
Southern First Bancshares increased earnings per share by a whopping 40% last year. And earnings per share have improved by 26% annually, over the last five years. With that performance, I would expect it to have an above average 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. 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 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.
So What Does Southern First Bancshares’s Balance Sheet Tell Us?
With net cash of US$74m, Southern First Bancshares has a very strong balance sheet, which may be important for its business. Having said that, at 23% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Southern First Bancshares’s P/E Ratio
Southern First Bancshares has a P/E of 11.8. That’s below the average in the US market, which is 19.0. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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.
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