U.S. Markets open in 8 hrs 52 mins

Here's How P/E Ratios Can Help Us Understand Community West Bancshares (NASDAQ:CWBC)

Simply Wall St

Of late the Community West Bancshares (NASDAQ:CWBC) share price has softened like an ice cream in the sun, melting a full . But plenty of shareholders will still be smiling, given that the stock is up 16% over the last quarter. The stock has been solid, longer term, gaining 12% in the last year.

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. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

Check out our latest analysis for Community West Bancshares

How Does Community West Bancshares's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 14.68 that there is some investor optimism about Community West Bancshares. As you can see below, Community West Bancshares has a higher P/E than the average company (13.1) in the banks industry.

NasdaqGM:CWBC Price Estimation Relative to Market, December 22nd 2019

Community West Bancshares's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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.

Community West Bancshares shrunk earnings per share by 1.3% last year. But it has grown its earnings per share by 3.7% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 2.4% annually. So it would be surprising to see a high P/E.

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. Thus, the metric does not reflect cash or debt held by the company. 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).

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.

How Does Community West Bancshares's Debt Impact Its P/E Ratio?

Community West Bancshares has net cash of US$11m. 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 Verdict On Community West Bancshares's P/E Ratio

Community West Bancshares has a P/E of 14.7. That's below the average in the US market, which is 18.9. Falling earnings per share are likely to be keeping potential buyers away, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary. What can be absolutely certain is that the market has become less optimistic about Community West Bancshares over the last month, with the P/E ratio falling from 14.7 back then to 14.7 today. 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. 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. We don't have analyst forecasts, but you might want to assess this data-rich visualization 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 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.

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. Thank you for reading.