To the annoyance of some shareholders, Lake Shore Bancorp (NASDAQ:LSBK) shares are down a considerable 40% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 42% drop over twelve months.
All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). 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). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Lake Shore Bancorp's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 13.46 that there is some investor optimism about Lake Shore Bancorp. The image below shows that Lake Shore Bancorp has a higher P/E than the average (10.7) P/E for companies in the mortgage industry.
Lake Shore Bancorp's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. 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. 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.
Lake Shore Bancorp saw earnings per share improve by 3.3% last year. And earnings per share have improved by 4.4% annually, over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Lake Shore Bancorp's Balance Sheet
Lake Shore Bancorp's net debt is 5.2% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Lake Shore Bancorp's P/E Ratio
Lake Shore Bancorp trades on a P/E ratio of 13.5, which is fairly close to the US market average of 13.0. When you consider the modest EPS growth last year (along with some debt), it seems the market thinks the growth is sustainable. Given Lake Shore Bancorp's P/E ratio has declined from 22.6 to 13.5 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than Lake Shore 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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