Midland States Bancorp Inc (NASDAQ:MSBI) is trading with a trailing P/E of 16.1x, which is lower than the industry average of 18.3x. While this makes MSBI appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View our latest analysis for Midland States Bancorp
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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.
P/E Calculation for MSBI
Price-Earnings Ratio = Price per share ÷ Earnings per share
MSBI Price-Earnings Ratio = 31.85 ÷ 1.975 = 16.1x
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 MSBI, 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. MSBI’s P/E of 16.1x is lower than its industry peers (18.3x), which implies that each dollar of MSBI’s earnings is being undervalued by investors. As such, our analysis shows that MSBI represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy MSBI, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to MSBI, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with MSBI, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing MSBI to are fairly valued by the market. If this is violated, MSBI's P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on MSBI, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I've outlined above.
Are you a potential investor? If you are considering investing in MSBI, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Midland States Bancorp for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.