Coastway Bancorp Inc (NASDAQ:CWAY) is trading with a trailing P/E of 28.2x, which is higher than the industry average of 22.6x. 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Coastway Bancorp
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 CWAY
Price-Earnings Ratio = Price per share ÷ Earnings per share
CWAY Price-Earnings Ratio = $21.6 ÷ $0.766 = 28.2x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CWAY, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 28.2x, CWAY’s P/E is higher than its industry peers (22.6x). This implies that investors are overvaluing each dollar of CWAY’s earnings. Therefore, according to this analysis, CWAY is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your CWAY shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to CWAY. 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 CWAY, 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 CWAY to are fairly valued by the market. If this does not hold true, CWAY’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on CWAY, the overvaluation of the stock may mean it is a good time to reduce your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined above.
Are you a potential investor? If you are considering investing in CWAY, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Coastway Bancorp for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.