Southern Missouri Bancorp Inc (NASDAQ:SMBC) trades with a trailing P/E of 16.1x, which is lower than the industry average of 21.9x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Southern Missouri Bancorp
Breaking down the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 SMBC
Price-Earnings Ratio = Price per share ÷ Earnings per share
SMBC Price-Earnings Ratio = $36.39 ÷ $2.266 = 16.1x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SMBC, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 16.1x, SMBC’s P/E is lower than its industry peers (21.9x). This implies that investors are undervaluing each dollar of SMBC’s earnings. Therefore, according to this analysis, SMBC is an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy SMBC immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to SMBC, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with SMBC, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing SMBC to are fairly valued by the market. If this is violated, SMBC’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of SMBC to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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 SMBC’s future growth? Take a look at our free research report of analyst consensus for SMBC’s outlook.
- Past Track Record: Has SMBC 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 SMBC’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.