This article is intended for those of you who are at the beginning of your investing journey and want to learn about the link between company’s fundamentals and stock market performance.
Access National Corporation (NASDAQ:ANCX) is currently trading at a trailing P/E of 27x, which is higher than the industry average of 16.6x. While ANCX 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Demystifying 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for ANCX
Price per share = $28.96
Earnings per share = $1.074
∴ Price-Earnings Ratio = $28.96 ÷ $1.074 = 27x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 ANCX, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
At 27x, ANCX’s P/E is higher than its industry peers (16.6x). This implies that investors are overvaluing each dollar of ANCX’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. Therefore, according to this analysis, ANCX is an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that ANCX 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 ANCX. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing riskier firms with ANCX, then ANCX’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with ANCX. In this case, ANCX’s P/E would be higher since investors would also reward ANCX’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing ANCX to are fairly valued by the market. If this does not hold, there is a possibility that ANCX’s P/E is higher because firms in our peer group are being undervalued by the market.
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 ANCX. 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 ANCX’s future growth? Take a look at our free research report of analyst consensus for ANCX’s outlook.
- Past Track Record: Has ANCX 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 ANCX’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 pass 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 email@example.com.