Should You Be Tempted To Sell Heritage Commerce Corp (HTBK) Because Of Its PE Ratio?
Heritage Commerce Corp (NASDAQ:HTBK) trades with a trailing P/E of 19.7x, which is higher than the industry average of 18.5x. While HTBK might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Heritage Commerce
Breaking down the Price-Earnings 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 HTBK
Price-Earnings Ratio = Price per share ÷ Earnings per share
HTBK Price-Earnings Ratio = 14.51 ÷ 0.737 = 19.7x
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 HTBK, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since HTBK's P/E of 19.7x is higher than its industry peers (18.5x), it means that investors are paying more than they should for each dollar of HTBK's earnings. Therefore, according to this analysis, HTBK is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your HTBK shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to HTBK. 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 HTBK, 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 HTBK to are fairly valued by the market. If this is violated, HTBK's P/E may be lower than its peers as they are actually overvalued by investors.
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 HTBK. 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 you are considering investing in HTBK, looking at the PE ratio on its own is not enough to make a well-informed decision. You will benefit from looking at additional analysis and considering its intrinsic valuation along with other relative valuation metrics like PEG and EV/Sales.
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 Heritage Commerce 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.
