American River Bankshares (NASDAQ:AMRB) shares have retraced a considerable in the last month. But plenty of shareholders will still be smiling, given that the stock is up 12% over the last quarter. Zooming out, the recent drop wiped out a year's worth of gains, with the share price now back where it was a year ago.
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). So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does American River Bankshares Have A Relatively High Or Low P/E For Its Industry?
American River Bankshares's P/E of 17.06 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (12.7) for companies in the banks industry is lower than American River Bankshares's P/E.
Its relatively high P/E ratio indicates that American River Bankshares shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
American River Bankshares's earnings made like a rocket, taking off 54% last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does American River Bankshares's Balance Sheet Tell Us?
With net cash of US$14m, American River Bankshares has a very strong balance sheet, which may be important for its business. Having said that, at 15% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On American River Bankshares's P/E Ratio
American River Bankshares's P/E is 17.1 which is about average (18.4) in the US market. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect American River Bankshares to have a higher P/E ratio. All the more so, since analysts expect further profit growth. Click here to research this potential opportunity.. Given American River Bankshares's P/E ratio has declined from 17.1 to 17.1 in the last month, we know for sure that the market is less confident about the business today, than it was back then. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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 email@example.com. 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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