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Here's How P/E Ratios Can Help Us Understand Central Valley Community Bancorp (NASDAQ:CVCY)

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Central Valley Community Bancorp's (NASDAQ:CVCY) P/E ratio to inform your assessment of the investment opportunity. Central Valley Community Bancorp has a price to earnings ratio of 12.32, based on the last twelve months. That is equivalent to an earnings yield of about 8.1%.

Check out our latest analysis for Central Valley Community Bancorp

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Central Valley Community Bancorp:

P/E of 12.32 = $20.23 ÷ $1.64 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Does Central Valley Community Bancorp's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Central Valley Community Bancorp has a P/E ratio that is fairly close for the average for the banks industry, which is 12.4.

NasdaqCM:CVCY Price Estimation Relative to Market, October 26th 2019

That indicates that the market expects Central Valley Community Bancorp will perform roughly in line with other companies in its industry. So if Central Valley Community Bancorp actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

It's nice to see that Central Valley Community Bancorp grew EPS by a stonking 37% in the last year. And earnings per share have improved by 13% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

Central Valley Community Bancorp's Balance Sheet

Central Valley Community Bancorp has net cash of US$33m. This is fairly high at 12% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Central Valley Community Bancorp's P/E Ratio

Central Valley Community Bancorp's P/E is 12.3 which is below average (17.8) in the US market. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.

Investors should be looking to buy stocks that the market is wrong about. 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.