Live Oak Bancshares Inc (NASDAQ:LOB) trades with a trailing P/E of 25.4x, which is higher than the industry average of 17x. While this makes LOB appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Live Oak Bancshares
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for LOB
Price-Earnings Ratio = Price per share ÷ Earnings per share
LOB Price-Earnings Ratio = $24.7 ÷ $0.974 = 25.4x
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 LOB, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since LOB’s P/E of 25.4x is higher than its industry peers (17x), it means that investors are paying more than they should for each dollar of LOB’s earnings. Therefore, according to this analysis, LOB is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your LOB shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to LOB, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with LOB, 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 LOB to are fairly valued by the market. If this does not hold, there is a possibility that LOB’s P/E is lower because our peer group is overvalued by the market.
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.