Patriot National Bancorp Inc (NASDAQ:PNBK) is trading with a trailing P/E of 21.8x, which is higher than the industry average of 17.1x. While this makes PNBK 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. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Patriot National Bancorp
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 PNBK
Price-Earnings Ratio = Price per share ÷ Earnings per share
PNBK Price-Earnings Ratio = $19.5 ÷ $0.893 = 21.8x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to PNBK, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. PNBK’s P/E of 21.8x is higher than its industry peers (17.1x), which implies that each dollar of PNBK’s earnings is being overvalued by investors. Therefore, according to this analysis, PNBK is an over-priced stock.
A few caveats
Before you jump to the conclusion that PNBK should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to PNBK, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with PNBK, 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 PNBK to are fairly valued by the market. If this does not hold true, PNBK’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 PNBK. 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:
- Future Outlook: What are well-informed industry analysts predicting for PNBK’s future growth? Take a look at our free research report of analyst consensus for PNBK’s outlook.
- Past Track Record: Has PNBK 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 PNBK’s historicals for more clarity.
- 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 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.