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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Banco de Sabadell, S.A.’s (BME:SAB) P/E ratio and reflect on what it tells us about the company’s share price. Banco de Sabadell has a P/E ratio of 18.28, based on the last twelve months. In other words, at today’s prices, investors are paying €18.28 for every €1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Banco de Sabadell:
P/E of 18.28 = €0.91 ÷ €0.050 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each €1 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.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Banco de Sabadell saw earnings per share decrease by 67% last year. And EPS is down 30% a year, over the last 3 years. This growth rate might warrant a low P/E ratio.
How Does Banco de Sabadell’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Banco de Sabadell has a higher P/E than the average company (9.6) in the banks industry.
Banco de Sabadell’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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).
Banco de Sabadell’s Balance Sheet
Banco de Sabadell has net debt worth a very significant 126% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Bottom Line On Banco de Sabadell’s P/E Ratio
Banco de Sabadell’s P/E is 18.3 which is about average (17.6) in the ES market. With significant debt and no EPS growth last year, the P/E suggests shareholders are expecting higher profit in the future.
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.
You might be able to find a better buy than Banco de Sabadell. 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).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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. Thank you for reading.