Codorus Valley Bancorp Inc (NASDAQ:CVLY) trades with a trailing P/E of 15.3x, which is lower than the industry average of 19.9x. 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Codorus Valley Bancorp
Breaking down the P/E ratio
P/E is a popular ratio used for relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for CVLY
Price per share = 26.08
Earnings per share = 1.706
∴ Price-Earnings Ratio = 26.08 ÷ 1.706 = 15.3x
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. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as CVLY, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 15.3x, CVLY’s P/E is lower than its industry peers (19.9x). This implies that investors are undervaluing each dollar of CVLY’s earnings. As such, our analysis shows that CVLY represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy CVLY immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to CVLY. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you inadvertently compared lower risk firms with CVLY, then investors would naturally value CVLY at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with CVLY, investors would also value CVLY at a lower price since it is a lower growth investment. Both scenarios would explain why CVLY has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing CVLY to are fairly valued by the market. If this does not hold, there is a possibility that CVLY’s P/E is lower because firms in our peer group are being overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on CVLY, the undervaluation of the stock may mean it is a good time to top up on 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 CVLY has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
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 Codorus Valley 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.