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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Hawthorn Bancshares, Inc.’s (NASDAQ:HWBK) P/E ratio to inform your assessment of the investment opportunity. Hawthorn Bancshares has a price to earnings ratio of 12.41, based on the last twelve months. In other words, at today’s prices, investors are paying $12.41 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Hawthorn Bancshares:
P/E of 12.41 = $26.3 ÷ $2.12 (Based on the year to March 2019.)
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 isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Hawthorn Bancshares’s 292% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 17% per year over three years. So we’d absolutely expect it to have a relatively high P/E ratio.
How Does Hawthorn Bancshares’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (12.7) for companies in the banks industry is roughly the same as Hawthorn Bancshares’s P/E.
Hawthorn Bancshares’s P/E tells us that market participants think its prospects are roughly in line with its industry. So if Hawthorn Bancshares 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
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its 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 Hawthorn Bancshares’s Debt Impact Its P/E Ratio?
Net debt is 38% of Hawthorn Bancshares’s market cap. You’d want to be aware of this fact, but it doesn’t bother us.
The Bottom Line On Hawthorn Bancshares’s P/E Ratio
Hawthorn Bancshares trades on a P/E ratio of 12.4, which is below the US market average of 17.9. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
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. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Hawthorn Bancshares 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).
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.