Auburn National Bancorporation Inc (NASDAQ:AUBN) is trading with a trailing P/E of 16.1x, which is lower than the industry average of 18.6x. While this makes AUBN appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. 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 AUBN
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief 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.
P/E Calculation for AUBN
Price-Earnings Ratio = Price per share ÷ Earnings per share
AUBN Price-Earnings Ratio = 35 ÷ 2.172 = 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 AUBN, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. AUBN’s P/E of 16.1x is lower than its industry peers (18.6x), which implies that each dollar of AUBN’s earnings is being undervalued by investors. Therefore, according to this analysis, AUBN is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy AUBN immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to AUBN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with AUBN, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing AUBN to are fairly valued by the market. If this is violated, AUBN’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? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of AUBN to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in AUBN, 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 Auburn National Bancorporation 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.