The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Bank of Hawaii Corporation (NYSE:BOH) is trading with a trailing P/E of 16.8x, which is lower than the industry average of 17.8x. While BOH might seem like an attractive stock to buy, 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.
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 BOH
Price-Earnings Ratio = Price per share ÷ Earnings per share
BOH Price-Earnings Ratio = $78.91 ÷ $4.697 = 16.8x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as BOH, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since BOH’s P/E of 16.8 is lower than its industry peers (17.8), it means that investors are paying less for each dollar of BOH’s earnings. This multiple is a median of profitable companies of 25 Banks companies in US including Great Basin Financial, CIB Marine Bancshares and Citizens Commerce Bancshares. You can think of it like this: the market is suggesting that BOH is a weaker business than the average comparable company.
A few caveats
However, 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 BOH, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with BOH, 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 BOH to are fairly valued by the market. If this is violated, BOH’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to BOH. 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. 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 BOH’s future growth? Take a look at our free research report of analyst consensus for BOH’s outlook.
- Past Track Record: Has BOH been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of BOH’s historicals for more clarity.
- 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.
To help readers see past 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. For errors that warrant correction please contact the editor at email@example.com.