BCB Bancorp Inc (NASDAQ:BCBP) is trading with a trailing P/E of 21.1x, which is higher than the industry average of 17.8x. While BCBP might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for BCB Bancorp
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 BCBP
Price-Earnings Ratio = Price per share ÷ Earnings per share
BCBP Price-Earnings Ratio = $15.95 ÷ $0.755 = 21.1x
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 BCBP, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since BCBP’s P/E of 21.1x is higher than its industry peers (17.8x), it means that investors are paying more than they should for each dollar of BCBP’s earnings. As such, our analysis shows that BCBP represents an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your BCBP shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to BCBP, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with BCBP, 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 BCBP to are fairly valued by the market. If this does not hold true, BCBP’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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.