Of late the Community West Bancshares (NASDAQ:CWBC) share price has softened like an ice cream in the sun, melting a full . But there's still good reason for shareholders to be content; the stock has gained 12% in the last 90 days. Zooming out, the recent drop wiped out a year's worth of gains, with the share price now back where it was a year ago.
Assuming no other changes, a sharply higher share price makes a stock less 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.
How Does Community West Bancshares's P/E Ratio Compare To Its Peers?
Community West Bancshares's P/E of 13.84 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (12.7) for companies in the banks industry is lower than Community West Bancshares's P/E.
That means that the market expects Community West Bancshares will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Community West Bancshares saw earnings per share decrease by 1.3% last year. But EPS is up 3.7% over the last 3 years. And EPS is down 2.4% a year, over the last 5 years. So you wouldn't expect a very high P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Community West Bancshares's Balance Sheet
With net cash of US$11m, Community West Bancshares has a very strong balance sheet, which may be important for its business. Having said that, at 13% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Community West Bancshares's P/E Ratio
Community West Bancshares's P/E is 13.8 which is below average (18.4) in the US market. The recent drop in earnings per share would make investors cautious, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. What can be absolutely certain is that the market has become less optimistic about Community West Bancshares over the last month, with the P/E ratio falling from 13.8 back then to 13.8 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
You might be able to find a better buy than Community West Bancshares. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you spot an error that warrants correction, please contact the editor at email@example.com. 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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