Why Veritex Holdings, Inc.’s (NASDAQ:VBTX) High P/E Ratio Isn’t Necessarily A Bad Thing

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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at Veritex Holdings, Inc.’s (NASDAQ:VBTX) P/E ratio and reflect on what it tells us about the company’s share price. Veritex Holdings has a price to earnings ratio of 23.33, based on the last twelve months. In other words, at today’s prices, investors are paying $23.33 for every $1 in prior year profit.

See our latest analysis for Veritex Holdings

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 Veritex Holdings:

P/E of 23.33 = $26.75 ÷ $1.15 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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

Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Veritex Holdings saw earnings per share improve by -5.6% last year. And its annual EPS growth rate over 5 years is 13%.

Does Veritex Holdings Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Veritex Holdings has a higher P/E than the average (13.1) P/E for companies in the banks industry.

NasdaqGM:VBTX Price Estimation Relative to Market, May 6th 2019
NasdaqGM:VBTX Price Estimation Relative to Market, May 6th 2019

Veritex Holdings’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.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 Veritex Holdings’s Balance Sheet Tell Us?

The extra options and safety that comes with Veritex Holdings’s US$11m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Veritex Holdings’s P/E Ratio

Veritex Holdings’s P/E is 23.3 which is above average (18.4) in the US market. Earnings improved over the last year. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Veritex Holdings 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 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.