Unfortunately for some shareholders, the Silvergate Capital (NYSE:SI) share price has dived 41% in the last thirty days. The bad news is that the recent drop obliterated the last year's worth of gains; the stock is flat over twelve months.
All else being equal, a share price drop should make a stock more attractive to potential investors. 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. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Silvergate Capital Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 6.97 that sentiment around Silvergate Capital isn't particularly high. We can see in the image below that the average P/E (8.6) for companies in the banks industry is higher than Silvergate Capital's P/E.
This suggests that market participants think Silvergate Capital will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Silvergate Capital saw earnings per share improve by 2.5% last year. And it has bolstered its earnings per share by 14% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Silvergate Capital's Balance Sheet
Silvergate Capital has net cash of US$89m. This is fairly high at 50% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Silvergate Capital's P/E Ratio
Silvergate Capital has a P/E of 7.0. That's below the average in the US market, which is 12.6. Recent earnings growth wasn't bad. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations. What can be absolutely certain is that the market has become more pessimistic about Silvergate Capital over the last month, with the P/E ratio falling from 11.8 back then to 7.0 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Silvergate Capital 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).
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.
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