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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Australia and New Zealand Banking Group Limited's (ASX:ANZ) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Australia and New Zealand Banking Group has a P/E ratio of 12.28. That is equivalent to an earnings yield of about 8.1%.
How Do I Calculate Australia and New Zealand Banking Group's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Australia and New Zealand Banking Group:
P/E of 12.28 = A$27.59 ÷ A$2.25 (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 A$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
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.
Australia and New Zealand Banking Group saw earnings per share decrease by 11% last year. And EPS is down 2.0% a year, over the last 5 years. This could justify a pessimistic P/E.
Does Australia and New Zealand Banking Group 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. The image below shows that Australia and New Zealand Banking Group has a P/E ratio that is roughly in line with the banks industry average (12.6).
Its P/E ratio suggests that Australia and New Zealand Banking Group shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
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.
So What Does Australia and New Zealand Banking Group's Balance Sheet Tell Us?
The extra options and safety that comes with Australia and New Zealand Banking Group's AU$5.7b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Australia and New Zealand Banking Group's P/E Ratio
Australia and New Zealand Banking Group's P/E is 12.3 which is below average (15.9) in the AU market. The recent drop in earnings per share would make investors cautious, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Australia and New Zealand Banking Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.