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 Provident Bancorp Inc’s (NASDAQ:PVBC) P/E ratio could help you assess the value on offer. Provident Bancorp has a P/E ratio of 30.47, based on the last twelve months. That is equivalent to an earnings yield of about 3.3%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Provident Bancorp:
P/E of 30.47 = $27.18 ÷ $0.89 (Based on the year to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Provident Bancorp saw earnings per share improve by -3.8% last year. And it has improved its earnings per share by 30% per year over the last three years. In contrast, EPS has decreased by 103%, annually, over 5 years.
How Does Provident Bancorp’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 (17.6) for companies in the mortgage industry is lower than Provident Bancorp’s P/E.
Its relatively high P/E ratio indicates that Provident Bancorp shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
How Does Provident Bancorp’s Debt Impact Its P/E Ratio?
Provident Bancorp’s net debt is 1.5% of its market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Provident Bancorp’s P/E Ratio
Provident Bancorp has a P/E of 30.5. That’s higher than the average in the US market, which is 18. Given the debt is only modest, and earnings are already moving in the right direction, it’s not surprising that the market expects continued improvement.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Provident Bancorp. 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 email@example.com.