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.
Salisbury Bancorp Inc (NASDAQ:SAL) trades on a trailing P/E of 17.5. This isn’t too far from the industry average (which is 17.7). 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.
Demystifying 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 SAL
Price-Earnings Ratio = Price per share ÷ Earnings per share
SAL Price-Earnings Ratio = $42 ÷ $2.397 = 17.5x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to SAL, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Salisbury Bancorp Inc (NASDAQ:SAL) is currently trading at a trailing P/E of 17.5, which is close to the industry average of 17.7. This multiple is a median of profitable companies of 25 Banks companies in US including Great Basin Financial, Mercantil Servicios Financieros C.A and CIB Marine Bancshares. One could put it like this: the market is pricing SAL as if it is roughly average for its industry.
A few caveats
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to SAL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with SAL, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing SAL to are fairly valued by the market. If this does not hold, there is a possibility that SAL’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on SAL, 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. 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 SAL’s future growth? Take a look at our free research report of analyst consensus for SAL’s outlook.
- Past Track Record: Has SAL 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 SAL’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.