Sandy Spring Bancorp Inc (NASDAQ:SASR) trades with a trailing P/E of 16.4x, which is lower than the industry average of 16.4x. While this makes SASR appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Sandy Spring 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 SASR
Price-Earnings Ratio = Price per share ÷ Earnings per share
SASR Price-Earnings Ratio = $39.45 ÷ $2.412 = 16.4x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as SASR, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. SASR’s P/E of 16.4x is lower than its industry peers (16.4x), which implies that each dollar of SASR’s earnings is being undervalued by investors. As such, our analysis shows that SASR represents an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy SASR immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to SASR. 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 SASR, 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 SASR to are fairly valued by the market. If this does not hold, there is a possibility that SASR’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on SASR, 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 SASR 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 Sandy Spring 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.