This analysis is intended to introduce important early concepts to people who are starting to invest and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
SVB Financial Group (NASDAQ:SIVB) is currently trading at a trailing P/E of 20, which is higher than the industry average of 15.7. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, 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 SIVB
Price-Earnings Ratio = Price per share ÷ Earnings per share
SIVB Price-Earnings Ratio = $263.92 ÷ $13.217 = 20x
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 SIVB, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. Since SIVB’s P/E of 20 is higher than its industry peers (15.7), it means that investors are paying more for each dollar of SIVB’s earnings. This multiple is a median of profitable companies of 25 Banks companies in US including CIB Marine Bancshares, Citizens Commerce Bancshares and Limestone Bancorp. You could think of it like this: the market is pricing SIVB as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to SIVB. If not, the difference in P/E might be a result of other factors. For example, SVB Financial Group could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with SIVB are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
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 SIVB. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for SIVB’s future growth? Take a look at our free research report of analyst consensus for SIVB’s outlook.
- Past Track Record: Has SIVB 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 SIVB’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 firstname.lastname@example.org.