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 Auswide Bank Ltd’s (ASX:ABA) P/E ratio to inform your assessment of the investment opportunity. Auswide Bank has a P/E ratio of 12.86, based on the last twelve months. That means that at current prices, buyers pay A$12.86 for every A$1 in trailing yearly profits.
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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 Auswide Bank:
P/E of 12.86 = A$5.32 ÷ A$0.41 (Based on the year to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Auswide Bank’s earnings per share grew by -9.3% in the last twelve months. And earnings per share have improved by 15% annually, over the last five years.
How Does Auswide Bank’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Auswide Bank has a lower P/E than the average (15.9) in the mortgage industry classification.
This suggests that market participants think Auswide Bank will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Auswide Bank’s Balance Sheet
Auswide Bank has net debt worth a very significant 184% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Bottom Line On Auswide Bank’s P/E Ratio
Auswide Bank’s P/E is 12.9 which is below average (15.2) in the AU market. While the recent EPS growth is a positive, the significant amount of debt on the balance sheet may be contributing to pessimistic market expectations.
Investors have an opportunity when market expectations about a stock are wrong. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Auswide Bank. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.