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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 First Financial Northwest, Inc.’s (NASDAQ:FFNW) P/E ratio to inform your assessment of the investment opportunity. First Financial Northwest has a P/E ratio of 15.51, based on the last twelve months. That corresponds to an earnings yield of approximately 6.4%.
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 First Financial Northwest:
P/E of 15.51 = $15.06 ÷ $0.97 (Based on the year to March 2019.)
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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. 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.
First Financial Northwest’s earnings per share fell by 23% in the last twelve months. But over the longer term (3 years), earnings per share have increased by 14%. And it has shrunk its earnings per share by 9.3% per year over the last five years. This could justify a pessimistic P/E.
Does First Financial Northwest Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below, First Financial Northwest has a higher P/E than the average company (12.7) in the banks industry.
First Financial Northwest’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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. Thus, the metric does not reflect cash or debt held by the company. 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.
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.
So What Does First Financial Northwest’s Balance Sheet Tell Us?
First Financial Northwest’s net debt is 93% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On First Financial Northwest’s P/E Ratio
First Financial Northwest trades on a P/E ratio of 15.5, which is below the US market average of 17.3. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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 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.