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What Does Orrstown Financial Services Inc’s (NASDAQ:ORRF) PE Ratio Tell You?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.

Orrstown Financial Services Inc (NASDAQ:ORRF) trades on a trailing P/E of 18.1. This isn’t too far from the industry average (which is 17.8). Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.

See our latest analysis for Orrstown Financial Services

Demystifying the P/E ratio

NasdaqCM:ORRF PE PEG Gauge September 28th 18

P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 ORRF

Price-Earnings Ratio = Price per share ÷ Earnings per share

ORRF Price-Earnings Ratio = $23.3 ÷ $1.289 = 18.1x

The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as ORRF, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Orrstown Financial Services Inc (NASDAQ:ORRF) is currently trading at a trailing P/E of 18.1, which is close to the industry average of 17.8. This multiple is a median of profitable companies of 25 Banks companies in US including Great Basin Financial, Mercantil Servicios Financieros C.A and CIB Marine Bancshares. One could put it like this: the market is pricing ORRF as if it is roughly average for its industry.

Assumptions to watch out for

However, you should be aware that this analysis makes certain assumptions. The first is that our “similar companies” are actually similar to ORRF. If not, the difference in P/E might be a result of other factors. For example, Orrstown Financial Services Inc 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 ORRF are not fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.

What this means for you:

If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in ORRF. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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:

  1. Future Outlook: What are well-informed industry analysts predicting for ORRF’s future growth? Take a look at our free research report of analyst consensus for ORRF’s outlook.
  2. Past Track Record: Has ORRF 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 ORRF’s historicals for more clarity.
  3. 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 editorial-team@simplywallst.com.