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Unfortunately for some shareholders, the Provident Bancorp (NASDAQ:PVBC) share price has dived 31% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 27% in the last year.
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. 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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Provident Bancorp Have A Relatively High Or Low P/E For Its Industry?
Provident Bancorp's P/E of 13.81 indicates some degree of optimism towards the stock. The image below shows that Provident Bancorp has a higher P/E than the average (10.9) P/E for companies in the mortgage industry.
That means that the market expects Provident Bancorp will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's great to see that Provident Bancorp grew EPS by 21% in the last year. And it has improved its earnings per share by 21% per year over the last three years. So one might expect an above average P/E ratio. But earnings per share are down 48% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Provident Bancorp's Balance Sheet
With net cash of US$35m, Provident Bancorp has a very strong balance sheet, which may be important for its business. Having said that, at 21% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Provident Bancorp's P/E Ratio
Provident Bancorp has a P/E of 13.8. That's around the same as the average in the US market, which is 13.3. Considering its recent growth, alongside its lack of debt, it would appear that the market isn't very excited about the future. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here. 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 19.9 back then to 13.8 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.
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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Provident Bancorp. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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