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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Community West Bancshares’s (NASDAQ:CWBC) P/E ratio and reflect on what it tells us about the company’s share price. Community West Bancshares has a P/E ratio of 11.69, based on the last twelve months. That corresponds to an earnings yield of approximately 8.6%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Community West Bancshares:
P/E of 11.69 = $10.4 ÷ $0.89 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, Community West Bancshares grew EPS by a whopping 48% in the last year. And its annual EPS growth rate over 3 years is 20%. With that performance, I would expect it to have an above average P/E ratio. In contrast, EPS has decreased by 5.4%, annually, over 5 years.
How Does Community West Bancshares’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (13.2) for companies in the banks industry is higher than Community West Bancshares’s P/E.
This suggests that market participants think Community West Bancshares will underperform other companies in its industry. Since the market seems unimpressed with Community West Bancshares, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Community West Bancshares’s Balance Sheet
Community West Bancshares’s net debt is 20% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Community West Bancshares’s P/E Ratio
Community West Bancshares’s P/E is 11.7 which is below average (16.8) in the US market. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don’t have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Community West Bancshares. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.