Should You Be Tempted To Sell Emclaire Financial Corp (NASDAQ:EMCF) Because Of Its P/E Ratio?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Emclaire Financial Corp’s (NASDAQ:EMCF) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Emclaire Financial’s P/E ratio is 16.06. That is equivalent to an earnings yield of about 6.2%.

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Check out our latest analysis for Emclaire Financial

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 Emclaire Financial:

P/E of 16.06 = $31.3 ÷ $1.95 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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

When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Emclaire Financial shrunk earnings per share by 7.3% last year.

How Does Emclaire Financial’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (12.8) for companies in the banks industry is lower than Emclaire Financial’s P/E.

NasdaqCM:EMCF Price Estimation Relative to Market, May 26th 2019
NasdaqCM:EMCF Price Estimation Relative to Market, May 26th 2019

That means that the market expects Emclaire Financial will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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).

So What Does Emclaire Financial’s Balance Sheet Tell Us?

Emclaire Financial has net debt equal to 27% of its market cap. You’d want to be aware of this fact, but it doesn’t bother us.

The Verdict On Emclaire Financial’s P/E Ratio

Emclaire Financial trades on a P/E ratio of 16.1, which is below the US market average of 17.5. With only modest debt, it’s likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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 editorial-team@simplywallst.com. 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.