The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Union Bankshares Inc (NASDAQ:UNB) trades with a trailing P/E of 22.1, which is higher than the industry average of 16.3. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
What you need to know about the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for UNB
Price-Earnings Ratio = Price per share ÷ Earnings per share
UNB Price-Earnings Ratio = $47.04 ÷ $2.126 = 22.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to UNB, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. UNB’s P/E of 22.1 is higher than its industry peers (16.3), which implies that each dollar of UNB’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Banks companies in US including CIB Marine Bancshares, Citizens Commerce Bancshares and Limestone Bancorp. You could think of it like this: the market is pricing UNB as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to UNB. If this isn’t the case, the difference in P/E could be due to other factors. For example, Union Bankshares Inc could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with UNB are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in UNB. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for UNB’s future growth? Take a look at our free research report of analyst consensus for UNB’s outlook.
- Past Track Record: Has UNB been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of UNB’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.