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Unfortunately for some shareholders, the Southern National Bancorp of Virginia (NASDAQ:SONA) share price has dived 33% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 31% in that time.
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). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Southern National Bancorp of Virginia Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 7.38 that sentiment around Southern National Bancorp of Virginia isn't particularly high. The image below shows that Southern National Bancorp of Virginia has a lower P/E than the average (9.0) P/E for companies in the banks industry.
This suggests that market participants think Southern National Bancorp of Virginia will underperform other companies in its industry. Since the market seems unimpressed with Southern National Bancorp of Virginia, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Southern National Bancorp of Virginia saw earnings per share decrease by 1.7% last year. But over the longer term (5 years) earnings per share have increased by 17%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Southern National Bancorp of Virginia's Balance Sheet
Southern National Bancorp of Virginia's net debt is 64% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Bottom Line On Southern National Bancorp of Virginia's P/E Ratio
Southern National Bancorp of Virginia has a P/E of 7.4. That's below the average in the US market, which is 13.4. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage. Given Southern National Bancorp of Virginia's P/E ratio has declined from 11.1 to 7.4 in the last month, we know for sure that the market is more worried 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 deep value investors this stock might justify some research.
Investors should be looking to buy stocks that the market is wrong about. 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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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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