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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 Banco Santander, S.A.'s (BME:SAN) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Banco Santander has a P/E ratio of 9.01. In other words, at today's prices, investors are paying €9.01 for every €1 in prior year profit.
Check out our latest analysis for Banco Santander
How Do You Calculate Banco Santander's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Banco Santander:
P/E of 9.01 = €3.72 ÷ €0.41 (Based on the trailing twelve months to June 2019.)
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. 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 Does Banco Santander's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below Banco Santander has a P/E ratio that is fairly close for the average for the banks industry, which is 9.1.
Banco Santander's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Banco Santander increased earnings per share by 5.8% last year. And its annual EPS growth rate over 3 years is 12%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).