The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Public Joint Stock Company Best Efforts Bank’s (MCX:ALBK) P/E ratio could help you assess the value on offer. Based on the last twelve months, Best Efforts Bank’s P/E ratio is 80. That corresponds to an earnings yield of approximately 1.3%.
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 Best Efforts Bank:
P/E of 80 = RUB90 ÷ RUB1.13 (Based on the year to October 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each RUB1 of company earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Best Efforts Bank shrunk earnings per share by 28% over the last year. But over the longer term (5 years) earnings per share have increased by 22%. And it has shrunk its earnings per share by 4.4% per year over the last three years. This growth rate might warrant a low P/E ratio. This growth rate might warrant a low P/E ratio.
How Does Best Efforts Bank’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, Best Efforts Bank has a much higher P/E than the average company (16.9) in the capital markets industry.
Best Efforts Bank’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 delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
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).
Best Efforts Bank’s Balance Sheet
Best Efforts Bank has net cash of RUруб1.9b. 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 Best Efforts Bank’s P/E Ratio
Best Efforts Bank’s P/E is 80 which is way above average (7.2) in the RU market. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Best Efforts Bank may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.