This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Heritage Commerce Corp’s (NASDAQ:HTBK) P/E ratio and reflect on what it tells us about the company’s share price. What is Heritage Commerce’s P/E ratio? Well, based on the last twelve months it is 13.76. That is equivalent to an earnings yield of about 7.3%.
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 Heritage Commerce:
P/E of 13.76 = USD11.93 ÷ USD0.87 (Based on the trailing twelve months to December 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 isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Heritage Commerce 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 (12.6) for companies in the banks industry is lower than Heritage Commerce’s P/E.
Heritage Commerce’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Heritage Commerce had pretty flat EPS growth in the last year. But it has grown its earnings per share by 16% per year over the last five years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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.
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.
Heritage Commerce’s Balance Sheet
Heritage Commerce has net cash of US$17m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Heritage Commerce’s P/E Ratio
Heritage Commerce has a P/E of 13.8. That’s below the average in the US market, which is 18.6. EPS was up modestly better over the last twelve months. And the net cash position gives the company many options. So it’s strange that the low P/E indicates low expectations. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here.
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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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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