Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
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 mBank S.A.'s (WSE:MBK) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, mBank's P/E ratio is 16.81. In other words, at today's prices, investors are paying PLN16.81 for every PLN1 in prior year profit.
See our latest analysis for mBank
How Do I Calculate mBank's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for mBank:
P/E of 16.81 = PLN424.2 ÷ PLN25.23 (Based on the trailing twelve months 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 PLN1 of company earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
mBank saw earnings per share decrease by 17% last year. And EPS is down 2.7% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
How Does mBank's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that mBank has a higher P/E than the average (13.9) P/E for companies in the banks industry.
mBank'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 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
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.