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Despite Its High P/E Ratio, Is Wellesley Bancorp, Inc. (NASDAQ:WEBK) Still Undervalued?

Simply Wall St

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 Wellesley Bancorp, Inc.'s ( NASDAQ:WEBK ) P/E ratio to inform your assessment of the investment opportunity. Wellesley Bancorp has a price to earnings ratio of 12.88 , based on the last twelve months. That means that at current prices, buyers pay $12.88 for every $1 in trailing yearly profits.

See our latest analysis for Wellesley Bancorp

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 Wellesley Bancorp:

P/E of 12.88 = $31.5 ÷ $2.45 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 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.

How Does Wellesley Bancorp's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Wellesley Bancorp has a P/E ratio that is roughly in line with the banks industry average (12.2).

NasdaqCM:WEBK Price Estimation Relative to Market, August 23rd 2019

Its P/E ratio suggests that Wellesley Bancorp shareholders think that in the future it will perform about the same as other companies in its industry classification. 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

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Notably, Wellesley Bancorp grew EPS by a whopping 38% in the last year. And earnings per share have improved by 25% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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).

How Does Wellesley Bancorp's Debt Impact Its P/E Ratio?

Wellesley Bancorp's net debt is considerable, at 141% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.

The Bottom Line On Wellesley Bancorp's P/E Ratio

Wellesley Bancorp trades on a P/E ratio of 12.9, which is below the US market average of 17.4. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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: Wellesley Bancorp 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).

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 editorial-team@simplywallst.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.