I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
HMN Financial Inc (NASDAQ:HMNF) is currently trading at a trailing P/E of 16.8x, which is lower than the industry average of 18.8x. While HMNF might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it.
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for relative valuation. 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 HMNF
Price-Earnings Ratio = Price per share ÷ Earnings per share
HMNF Price-Earnings Ratio = $21.15 ÷ $1.258 = 16.8x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to HMNF, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. Since HMNF’s P/E of 16.8 is lower than its industry peers (18.8), it means that investors are paying less for each dollar of HMNF’s earnings. This multiple is a median of profitable companies of 25 Mortgage companies in US including Security National Financial, PennyMac Financial Services and Bank7. You can think of it like this: the market is suggesting that HMNF is a weaker business than the average comparable company.
Assumptions to be aware of
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to HMNF. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with HMNF, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing HMNF to are fairly valued by the market. If this does not hold true, HMNF’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to HMNF. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 HMNF’s future growth? Take a look at our free research report of analyst consensus for HMNF’s outlook.
- Past Track Record: Has HMNF 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 HMNF’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 past 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. For errors that warrant correction please contact the editor at email@example.com.