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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how Sterling Bancorp’s (NYSE:STL) P/E ratio could help you assess the value on offer. Sterling Bancorp has a P/E ratio of 10.74, based on the last twelve months. In other words, at today’s prices, investors are paying $10.74 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 Sterling Bancorp:
P/E of 10.74 = $21.43 ÷ $2 (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. 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
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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Sterling Bancorp’s earnings made like a rocket, taking off 141% last year. The cherry on top is that the five year growth rate was an impressive 72% per year. So I’d be surprised if the P/E ratio was not above average.
How Does Sterling 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. We can see in the image below that the average P/E (12.9) for companies in the banks industry is higher than Sterling Bancorp’s P/E.
This suggests that market participants think Sterling Bancorp will underperform other companies in its industry.
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. So it won’t reflect the advantage of cash, or disadvantage of debt. 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).
Sterling Bancorp’s Balance Sheet
Net debt totals 73% of Sterling Bancorp’s market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Sterling Bancorp’s P/E Ratio
Sterling Bancorp’s P/E is 10.7 which is below average (18.2) in the US market. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Sterling 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).
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 email@example.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.