To the annoyance of some shareholders, Central Pacific Financial (NYSE:CPF) shares are down a considerable 48% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 46% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Central Pacific Financial Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 7.24 that sentiment around Central Pacific Financial isn't particularly high. If you look at the image below, you can see Central Pacific Financial has a lower P/E than the average (8.9) in the banks industry classification.
Its relatively low P/E ratio indicates that Central Pacific Financial shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Central Pacific Financial had pretty flat EPS growth in the last year. But EPS is up 14% over the last 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Central Pacific Financial's Balance Sheet Tell Us?
Net debt is 50% of Central Pacific Financial's market cap. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On Central Pacific Financial's P/E Ratio
Central Pacific Financial has a P/E of 7.2. That's below the average in the US market, which is 12.2. EPS grew over the last twelve months, and debt levels are quite reasonable. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value. What can be absolutely certain is that the market has become more pessimistic about Central Pacific Financial over the last month, with the P/E ratio falling from 13.8 back then to 7.2 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Central Pacific Financial may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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