Is Horizon Bancorp’s (NASDAQ:HBNC) PE Ratio A Signal To Sell For Investors?
Horizon Bancorp (NASDAQ:HBNC) trades with a trailing P/E of 20x, which is higher than the industry average of 16.6x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Horizon Bancorp
Breaking down the P/E ratio
P/E is a popular ratio used for 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 HBNC
Price-Earnings Ratio = Price per share ÷ Earnings per share
HBNC Price-Earnings Ratio = $27.86 ÷ $1.394 = 20x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 HBNC, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. HBNC’s P/E of 20x is higher than its industry peers (16.6x), which implies that each dollar of HBNC’s earnings is being overvalued by investors. As such, our analysis shows that HBNC represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your HBNC shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to HBNC, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with HBNC, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing HBNC to are fairly valued by the market. If this is violated, HBNC’s P/E may be lower than its peers as they are actually overvalued by investors.
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 rebalance your portfolio and reduce your holdings in HBNC. 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 HBNC, 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 Horizon 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.
