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 Bank of Commerce Holdings’s (NASDAQ:BOCH) P/E ratio could help you assess the value on offer. Based on the last twelve months, Bank of Commerce Holdings’s P/E ratio is 18.02. That is equivalent to an earnings yield of about 5.6%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Bank of Commerce Holdings:
P/E of 18.02 = $12.1 ÷ $0.67 (Based on the year to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 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.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. 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.
Bank of Commerce Holdings maintained roughly steady earnings over the last twelve months. But it has grown its earnings per share by 6.0% per year over the last five years.
How Does Bank of Commerce Holdings’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Bank of Commerce Holdings has a higher P/E than the average company (15.8) in the banks industry.
Its relatively high P/E ratio indicates that Bank of Commerce Holdings shareholders think it will perform better than other companies in its industry classification. 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
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
How Does Bank of Commerce Holdings’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with Bank of Commerce Holdings’s US$67m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Bank of Commerce Holdings’s P/E Ratio
Bank of Commerce Holdings trades on a P/E ratio of 18, which is fairly close to the US market average of 18. Earnings improved over the last year. Also positive, the relatively strong balance sheet will allow for investment in growth. If this occurs the current P/E might prove to signify undervaluation.
Investors should be looking to buy stocks that the market is wrong about. 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.
But note: Bank of Commerce Holdings 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).
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.