The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
1st Constitution Bancorp (NASDAQ:FCCY) is currently trading at a trailing P/E of 20.6, which is higher than the industry average of 17.7. While this might not seem positive, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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.
P/E Calculation for FCCY
Price-Earnings Ratio = Price per share ÷ Earnings per share
FCCY Price-Earnings Ratio = $19.65 ÷ $0.955 = 20.6x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to FCCY, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. FCCY’s P/E of 20.6 is higher than its industry peers (17.7), which implies that each dollar of FCCY’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 25 Banks companies in US including Great Basin Financial, CIB Marine Bancshares and Citizens Commerce Bancshares. You could also say that the market is suggesting that FCCY is a stronger business than the average comparable company.
Assumptions to be aware of
However, it is important to note that our examination of the stock is based on certain assumptions. The first is that our “similar companies” are actually similar to FCCY. If not, the difference in P/E might be a result of other factors. For example, 1st Constitution Bancorp could be growing more quickly than the companies we’re comparing it with. In that case it would deserve a higher P/E ratio. Of course, it is possible that the stocks we are comparing with FCCY are not fairly valued. So while we can reasonably surmise that it is optimistically valued relative to a peer group, it might be fairly valued, if the peer group is undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to FCCY. 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 FCCY’s future growth? Take a look at our free research report of analyst consensus for FCCY’s outlook.
- Past Track Record: Has FCCY 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 FCCY’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 firstname.lastname@example.org.