I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Spirit of Texas Bancshares Inc (NASDAQ:STXB).
Spirit of Texas Bancshares Inc (NASDAQ:STXB) is currently trading at a trailing P/E of 23.2x, which is higher than the industry average of 17x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Spirit of Texas Bancshares
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as 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 STXB
Price per share = $20.8
Earnings per share = $0.895
∴ Price-Earnings Ratio = $20.8 ÷ $0.895 = 23.2x
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 STXB, 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.
STXB’s P/E of 23.2x is higher than its industry peers (17x), which implies that each dollar of STXB’s earnings is being overvalued by investors. As such, our analysis shows that STXB represents an over-priced stock.
A few caveats
However, before you rush out to sell your STXB shares, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to STXB. 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 STXB, then investors would naturally value STXB at a higher price since it is a less risky investment. Similarly, if you accidentally compared lower growth firms with STXB, investors would also value STXB at a higher price since it is a higher growth investment. Both scenarios would explain why STXB has a higher P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing STXB to are fairly valued by the market. If this does not hold, there is a possibility that STXB’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 STXB. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for STXB’s future growth? Take a look at our free research report of analyst consensus for STXB’s outlook.
- Financial Health: Is STXB’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- 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.