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Why Norwood Financial Corp.'s (NASDAQ:NWFL) High P/E Ratio Isn't Necessarily A Bad Thing

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Norwood Financial Corp.'s (NASDAQ:NWFL) P/E ratio could help you assess the value on offer. Based on the last twelve months, Norwood Financial's P/E ratio is 10.02. That corresponds to an earnings yield of approximately 10.0%.

View our latest analysis for Norwood Financial

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Norwood Financial:

P/E of 10.02 = $22.550 ÷ $2.250 (Based on the trailing twelve months to March 2020.)

(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 buyers have to pay a higher price for each $1 the company has earned over the last year. 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.

Does Norwood Financial Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below Norwood Financial has a P/E ratio that is fairly close for the average for the banks industry, which is 9.3.

NasdaqGM:NWFL Price Estimation Relative to Market May 25th 2020
NasdaqGM:NWFL Price Estimation Relative to Market May 25th 2020

That indicates that the market expects Norwood Financial will perform roughly in line with other companies in its industry. So if Norwood Financial actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Norwood Financial's earnings per share grew by 2.4% in the last twelve months. And its annual EPS growth rate over 5 years is 9.8%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. 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).

How Does Norwood Financial's Debt Impact Its P/E Ratio?

Norwood Financial's net debt equates to 38% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On Norwood Financial's P/E Ratio

Norwood Financial has a P/E of 10.0. That's below the average in the US market, which is 15.1. The company does have a little debt, and EPS is moving in the right direction. The P/E ratio implies the market is cautious about longer term prospects.

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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

But note: Norwood Financial may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.