United Bancorp Inc (NASDAQ:UBCP) is currently trading at a trailing P/E of 16.1x, which is lower than the industry average of 18.3x. While UBCP 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. In this article, 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 United Bancorp
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in 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 UBCP
Price-Earnings Ratio = Price per share ÷ Earnings per share
UBCP Price-Earnings Ratio = 11.8 ÷ 0.732 = 16.1x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to UBCP, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 16.1x, UBCP’s P/E is lower than its industry peers (18.3x). This implies that investors are undervaluing each dollar of UBCP’s earnings. Therefore, according to this analysis, UBCP is an under-priced stock.
A few caveats
While our conclusion might prompt you to buy UBCP immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to UBCP, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with UBCP, 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 UBCP to are fairly valued by the market. If this does not hold true, UBCP’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 UBCP 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 UBCP, 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 United Bancorp 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.