To the annoyance of some shareholders, Provident Bancorp (NASDAQ:PVBC) shares are down a considerable 56% in the last month. That drop has capped off a tough year for shareholders, with the share price down 59% in that time.
Assuming nothing else has changed, a lower share price makes a stock more 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. The implication here is that long term investors have an opportunity when expectations of a company are too low. 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.
How Does Provident Bancorp's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 10.37 that sentiment around Provident Bancorp isn't particularly high. We can see in the image below that the average P/E (14.5) for companies in the mortgage industry is higher than Provident Bancorp's P/E.
This suggests that market participants think Provident Bancorp will underperform other companies in its industry. Since the market seems unimpressed with Provident Bancorp, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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. When earnings grow, the 'E' increases, over time. 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.
Provident Bancorp's earnings per share grew by -7.7% in the last twelve months. And it has improved its earnings per share by 30% per year over the last three years.
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. 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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Provident Bancorp's Balance Sheet
Provident Bancorp has net debt equal to 25% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Provident Bancorp's P/E Ratio
Provident Bancorp trades on a P/E ratio of 10.4, which is below the US market average of 17.7. EPS grew over the last twelve months, and debt levels are quite reasonable. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value. What can be absolutely certain is that the market has become significantly less optimistic about Provident Bancorp over the last month, with the P/E ratio falling from 23.6 back then to 10.4 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Provident Bancorp may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 firstname.lastname@example.org. 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.