To the annoyance of some shareholders, First Bancorp (NASDAQ:FNLC) shares are down a considerable 35% in the last month. That drop has capped off a tough year for shareholders, with the share price down 30% in that time.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does First Bancorp Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 7.82 that sentiment around First Bancorp isn’t particularly high. The image below shows that First Bancorp has a lower P/E than the average (9.7) P/E for companies in the banks industry.
Its relatively low P/E ratio indicates that First Bancorp shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with First Bancorp, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. When earnings grow, the ‘E’ increases, over time. 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.
First Bancorp’s earnings per share grew by -8.1% in the last twelve months. And its annual EPS growth rate over 5 years is 11%.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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).
How Does First Bancorp’s Debt Impact Its P/E Ratio?
Net debt totals 75% of First Bancorp’s market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On First Bancorp’s P/E Ratio
First Bancorp’s P/E is 7.8 which is below average (13.3) in the US market. The meaningful debt load is probably contributing to low expectations, even though it has improved earnings recently. Given First Bancorp’s P/E ratio has declined from 12.0 to 7.8 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. Although we don’t have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than First 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 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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