This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Evans Bancorp, Inc.’s (NYSEMKT:EVBN) P/E ratio could help you assess the value on offer. Evans Bancorp has a P/E ratio of 10.61, based on the last twelve months. That is equivalent to an earnings yield of about 9.4%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Evans Bancorp:
P/E of 10.61 = $36.05 ÷ $3.4 (Based on the year to December 2018.)
Is A High P/E 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
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Evans Bancorp’s earnings made like a rocket, taking off 54% last year. Even better, EPS is up 22% per year over three years. So we’d absolutely expect it to have a relatively high P/E ratio.
Does Evans Bancorp Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Evans Bancorp has a lower P/E than the average (12.9) P/E for companies in the banks industry.
Its relatively low P/E ratio indicates that Evans Bancorp shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or 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. 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.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Evans Bancorp’s Debt Impact Its P/E Ratio?
Evans Bancorp has net cash of US$15m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Evans Bancorp’s P/E Ratio
Evans Bancorp’s P/E is 10.6 which is below average (17.9) in the US market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don’t believe the strong growth will continue.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Evans 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).
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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.