U.S. Markets close in 5 hrs 29 mins

Do You Know What Community West Bancshares's (NASDAQ:CWBC) P/E Ratio Means?

Simply Wall St

Community West Bancshares (NASDAQ:CWBC) shares have retraced a considerable in the last month. But plenty of shareholders will still be smiling, given that the stock is up 17% over the last quarter. The stock has been solid, longer term, gaining 14% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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.

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 14.70 that there is some investor optimism about Community West Bancshares. The image below shows that Community West Bancshares has a higher P/E than the average (12.7) P/E for companies in the banks industry.

NasdaqGM:CWBC Price Estimation Relative to Market, January 24th 2020

That means that the market expects Community West Bancshares will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Community West Bancshares saw earnings per share decrease by 1.3% last year. But over the longer term (3 years), earnings per share have increased by 3.7%. And EPS is down 2.4% a year, over the last 5 years. So it would be surprising to see a high P/E.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Community West Bancshares's Balance Sheet

With net cash of US$11m, Community West Bancshares has a very strong balance sheet, which may be important for its business. Having said that, at 12% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

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 18.8. Falling earnings per share are likely to be keeping potential buyers away, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. 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 should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 be able to find a better stock than Community West Bancshares. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.