American National Bankshares Inc (NASDAQ:AMNB) trades with a trailing P/E of 21.8x, which is higher than the industry average of 17.5x. 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 explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for American National Bankshares
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 AMNB
Price-Earnings Ratio = Price per share ÷ Earnings per share
AMNB Price-Earnings Ratio = $38.5 ÷ $1.765 = 21.8x
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 AMNB, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since AMNB’s P/E of 21.8x is higher than its industry peers (17.5x), it means that investors are paying more than they should for each dollar of AMNB’s earnings. As such, our analysis shows that AMNB represents an over-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that AMNB should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to AMNB. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with AMNB, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing AMNB to are fairly valued by the market. If this does not hold, there is a possibility that AMNB’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 overvaluation could signal a potential selling opportunity to reduce your exposure to AMNB. 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 AMNB’s future growth? Take a look at our free research report of analyst consensus for AMNB’s outlook.
- Past Track Record: Has AMNB 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 AMNB’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 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.