Why Avanza Bank Holding AB (publ)'s (STO:AZA) High P/E Ratio Isn't Necessarily A Bad Thing

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Avanza Bank Holding AB (publ)'s (STO:AZA) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Avanza Bank Holding's P/E ratio is 32.71. That is equivalent to an earnings yield of about 3.1%.

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How Do You Calculate Avanza Bank Holding's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Avanza Bank Holding:

P/E of 32.71 = SEK422.8 ÷ SEK12.93 (Based on the trailing twelve months to September 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 SEK1 the company has earned over the last year. 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.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. 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.

Avanza Bank Holding's earnings per share were pretty steady over the last year. But over the longer term (5 years) earnings per share have increased by 12%. And EPS is down 3.2% a year, over the last 3 years. So we might expect a relatively low P/E.

How Does Avanza Bank Holding's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Avanza Bank Holding has a higher P/E than the average company (16.5) in the capital markets industry.

That means that the market expects Avanza Bank Holding will outperform other companies in its industry. 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.

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

Avanza Bank Holding's Balance Sheet

Since Avanza Bank Holding holds net cash of kr1.9b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Avanza Bank Holding's P/E Ratio

Avanza Bank Holding has a P/E of 32.7. That's higher than the average in the SE market, which is 15.3. EPS was up modestly better over the last twelve months. Also positive, the relatively strong balance sheet will allow for investment in growth -- and the P/E indicates shareholders that will happen!

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this freevisualization 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 freelist of companies with modest (or no) debt, trading on a P/E below 20.

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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.