The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Grong Sparebank's (OB:GRONG-ME) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Grong Sparebank's P/E ratio is 13.33. That corresponds to an earnings yield of approximately 7.5%.
Check out our latest analysis for Grong Sparebank
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 Grong Sparebank:
P/E of 13.33 = NOK113.000 ÷ NOK8.480 (Based on the trailing twelve months to December 2019.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each NOK1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Grong Sparebank Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (8.2) for companies in the banks industry is lower than Grong Sparebank's P/E.
Its relatively high P/E ratio indicates that Grong Sparebank shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Grong Sparebank's earnings per share fell by 12% in the last twelve months. And EPS is down 32% a year, over the last 5 years. This could justify a pessimistic P/E.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).