Those holding Live Oak Bancshares (NASDAQ:LOB) shares must be pleased that the share price has rebounded 53% in the last thirty days. But unfortunately, the stock is still down by 26% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 15% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Live Oak Bancshares Have A Relatively High Or Low P/E For Its Industry?
Live Oak Bancshares’s P/E of 31.14 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (8.9) for companies in the banks industry is a lot lower than Live Oak Bancshares’s P/E.
That means that the market expects Live Oak Bancshares will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. 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.
Live Oak Bancshares saw earnings per share decrease by 65% last year. But it has grown its earnings per share by 1.4% per year over the last five years.
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. Thus, the metric does not reflect cash or debt held by the company. 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).
Live Oak Bancshares’s Balance Sheet
With net cash of US$230m, Live Oak Bancshares has a very strong balance sheet, which may be important for its business. Having said that, at 41% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Live Oak Bancshares’s P/E Ratio
Live Oak Bancshares’s P/E is 31.1 which is above average (13.6) in its market. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What we know for sure is that investors have become much more excited about Live Oak Bancshares recently, since they have pushed its P/E ratio from 20.3 to 31.1 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is ‘blood in the streets’, then you may feel the opportunity has passed.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Live Oak Bancshares. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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