This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
Oritani Financial Corp (NASDAQ:ORIT) is trading with a trailing P/E of 17.1x, which is lower than the industry average of 18.8x. While this makes ORIT appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for ORIT
Price-Earnings Ratio = Price per share ÷ Earnings per share
ORIT Price-Earnings Ratio = $16.55 ÷ $0.970 = 17.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to ORIT, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since ORIT’s P/E of 17.1x is lower than its industry peers (18.8x), it means that investors are paying less than they should for each dollar of ORIT’s earnings. This multiple is a median of profitable companies of 25 Mortgage companies in US including Solutions Group, Security National Financial and PennyMac Financial Services. As such, our analysis shows that ORIT represents an under-priced stock.
A few caveats
Before you jump to the conclusion that ORIT is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to ORIT. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with ORIT, 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 ORIT to are fairly valued by the market. If this does not hold, there is a possibility that ORIT’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to ORIT. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for ORIT’s future growth? Take a look at our free research report of analyst consensus for ORIT’s outlook.
- Past Track Record: Has ORIT been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of ORIT’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.