Central Pacific Financial Corp (NYSE:CPF) is currently trading at a trailing P/E of 20.3x, which is higher than the industry average of 18.3x. While this makes CPF appear like a stock to avoid or sell if you own it, 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. Check out our latest analysis for Central Pacific Financial
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 CPF
Price-Earnings Ratio = Price per share ÷ Earnings per share
CPF Price-Earnings Ratio = 32.18 ÷ 1.586 = 20.3x
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 CPF, 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 CPF's P/E of 20.3x is higher than its industry peers (18.3x), it means that investors are paying more than they should for each dollar of CPF's earnings. As such, our analysis shows that CPF represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your CPF shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to CPF, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with CPF, 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 CPF to are fairly valued by the market. If this does not hold, there is a possibility that CPF’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in CPF. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If CPF 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 Central Pacific Financial 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.