DNB Financial Corporation (NASDAQ:DNBF) is currently trading at a trailing P/E of 15x, which is lower than the industry average of 16.7x. While DNBF 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 DNB Financial
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 DNBF
Price-Earnings Ratio = Price per share ÷ Earnings per share
DNBF Price-Earnings Ratio = $33.4 ÷ $2.227 = 15x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to DNBF, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. DNBF’s P/E of 15x is lower than its industry peers (16.7x), which implies that each dollar of DNBF’s earnings is being undervalued by investors. Therefore, according to this analysis, DNBF is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy DNBF, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to DNBF. 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 DNBF, 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 DNBF to are fairly valued by the market. If this does not hold true, DNBF’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of DNBF to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If you are considering investing in DNBF, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 DNB Financial 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.