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 The Bank of Princeton’s (NASDAQ:BPRN) P/E ratio could help you assess the value on offer. Bank of Princeton has a P/E ratio of 14.8, based on the last twelve months. That corresponds to an earnings yield of approximately 6.8%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Bank of Princeton:
P/E of 14.8 = $28.3 ÷ $1.91 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Bank of Princeton saw earnings per share decrease by 22% last year. But it has grown its earnings per share by 2.6% per year over the last five years. And it has shrunk its earnings per share by 8.2% per year over the last three years. This growth rate might warrant a low P/E ratio. This might lead to low expectations.
How Does Bank of Princeton’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (14.2) for companies in the banks industry is roughly the same as Bank of Princeton’s P/E.
Its P/E ratio suggests that Bank of Princeton shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Bank of Princeton actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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).
How Does Bank of Princeton’s Debt Impact Its P/E Ratio?
Bank of Princeton has net cash of US$6.9m. 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 Bank of Princeton’s P/E Ratio
Bank of Princeton’s P/E is 14.8 which is below average (16.1) in the US market. The recent drop in earnings per share would make investors cautious, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Bank of Princeton. 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).
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 firstname.lastname@example.org.