When Should You Buy PacWest Bancorp (PACW)?
PacWest Bancorp (NASDAQ:PACW) is currently trading at a trailing P/E of 17x, which is lower than the industry average of 18.5x. While PACW 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for PacWest Bancorp
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. 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 PACW
Price-Earnings Ratio = Price per share ÷ Earnings per share
PACW Price-Earnings Ratio = 49.28 ÷ 2.896 = 17x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as PACW, 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. At 17x, PACW’s P/E is lower than its industry peers (18.5x). This implies that investors are undervaluing each dollar of PACW’s earnings. As such, our analysis shows that PACW represents an under-priced stock.
Assumptions to watch out for
However, before you rush out to buy PACW, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to PACW. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with PACW, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing PACW to are fairly valued by the market. If this is violated, PACW'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? 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 PACW. 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 PACW has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 PacWest 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.
