Texas Capital Bancshares Inc (NASDAQ:TCBI) trades with a trailing P/E of 23x, which is higher than the industry average of 18.6x. While this makes TCBI 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 TCBI
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 TCBI
Price-Earnings Ratio = Price per share ÷ Earnings per share
TCBI Price-Earnings Ratio = 83.9 ÷ 3.641 = 23x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to TCBI, 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. Since TCBI's P/E of 23x is higher than its industry peers (18.6x), it means that investors are paying more than they should for each dollar of TCBI's earnings. Therefore, according to this analysis, TCBI is an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your TCBI shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to TCBI. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with TCBI, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing TCBI to are fairly valued by the market. If this does not hold true, TCBI’s lower P/E ratio may be because firms in our peer group are expensive by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to TCBI. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If TCBI has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 Texas Capital Bancshares 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.