Union Bankshares Corporation (NASDAQ:UBSH) is currently trading at a trailing P/E of 19.7x, which is higher than the industry average of 18.5x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Union Bankshares
Breaking down the P/E 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 UBSH
Price-Earnings Ratio = Price per share ÷ Earnings per share
UBSH Price-Earnings Ratio = 35.36 ÷ 1.794 = 19.7x
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 UBSH, 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. UBSH’s P/E of 19.7x is higher than its industry peers (18.5x), which implies that each dollar of UBSH’s earnings is being overvalued by investors. As such, our analysis shows that UBSH represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your UBSH shares, 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 UBSH, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with UBSH, 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 UBSH to are fairly valued by the market. If this does not hold true, UBSH’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? 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 UBSH. 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.
Are you a potential investor? If you are considering investing in UBSH, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 Union Bankshares 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.