Fauquier Bankshares (NASDAQ:FBSS) shares have retraced a considerable in the last month, but the stock is still up slightly on where it started the quarter. Looking back over the last year, the stock has been a solid performer, with a gain of 16%.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
How Does Fauquier Bankshares's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 11.64 that sentiment around Fauquier Bankshares isn't particularly high. The image below shows that Fauquier Bankshares has a lower P/E than the average (13.1) P/E for companies in the banks industry.
This suggests that market participants think Fauquier Bankshares will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, Fauquier Bankshares grew EPS like Taylor Swift grew her fan base back in 2010; the 69% gain was both fast and well deserved.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Fauquier Bankshares's Balance Sheet
With net cash of US$26m, Fauquier Bankshares has a very strong balance sheet, which may be important for its business. Having said that, at 33% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Fauquier Bankshares's P/E Ratio
Fauquier Bankshares's P/E is 11.6 which is below average (18.9) in the US market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. What can be absolutely certain is that the market has become less optimistic about Fauquier Bankshares over the last month, with the P/E ratio falling from 11.6 back then to 11.6 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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