Bancorp Of New Jersey Inc (AMEX:BKJ) is currently trading at a trailing P/E of 28.3x, which is higher than the industry average of 17.8x. While BKJ 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 deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for BKJ
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 BKJ
Price-Earnings Ratio = Price per share ÷ Earnings per share
BKJ Price-Earnings Ratio = 17.15 ÷ 0.606 = 28.3x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as BKJ, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since BKJ’s P/E of 28.3x is higher than its industry peers (17.8x), it means that investors are paying more than they should for each dollar of BKJ’s earnings. As such, our analysis shows that BKJ represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your BKJ shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to BKJ, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with BKJ, 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 BKJ to are fairly valued by the market. If this does not hold, there is a possibility that BKJ’s P/E is lower because our peer group is 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 BKJ. 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 BKJ, 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 Bancorp Of New Jersey 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.