Should You Be Tempted To Sell American National Bankshares Inc (NASDAQ:AMNB) At Its Current PE Ratio?

I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.

American National Bankshares Inc (NASDAQ:AMNB) is trading with a trailing P/E of 18.7x, which is higher than the industry average of 16.4x. While AMNB might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.

Check out our latest analysis for American National Bankshares

What you need to know about the P/E ratio

NasdaqGS:AMNB PE PEG Gauge August 2nd 18
NasdaqGS:AMNB PE PEG Gauge August 2nd 18

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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.

Formula

Price-Earnings Ratio = Price per share ÷ Earnings per share

P/E Calculation for AMNB

Price per share = $40.3

Earnings per share = $2.158

∴ Price-Earnings Ratio = $40.3 ÷ $2.158 = 18.7x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to AMNB, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.

At 18.7x, AMNB’s P/E is higher than its industry peers (16.4x). This implies that investors are overvaluing each dollar of AMNB’s earnings. This multiple is a median of profitable companies of 25 Banks companies in US including First Banking Center, Rising Sun Bancorp and Great Basin Financial. As such, our analysis shows that AMNB represents an over-priced stock.

Assumptions to watch out for

Before you jump to the conclusion that AMNB should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our peer group actually contains companies that are similar to AMNB. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared riskier firms with AMNB, then investors would naturally value AMNB at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with AMNB, investors would also value AMNB at a higher price since it is a higher growth investment. Both scenarios would explain why AMNB has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing AMNB to are fairly valued by the market. If this does not hold, there is a possibility that AMNB’s P/E is higher because firms in our peer group are being undervalued by the market.

NasdaqGS:AMNB Future Profit August 2nd 18
NasdaqGS:AMNB Future Profit August 2nd 18

What this means for you:

You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to AMNB. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 highly recommend you to complete your research by taking a look at the following:

  1. Future Outlook: What are well-informed industry analysts predicting for AMNB’s future growth? Take a look at our free research report of analyst consensus for AMNB’s outlook.
  2. Past Track Record: Has AMNB 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 AMNB’s historicals for more clarity.
  3. 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 editorial-team@simplywallst.com.