Should You Be Tempted To Sell Pacific Mercantile Bancorp (NASDAQ:PMBC) Because Of Its PE Ratio?
Pacific Mercantile Bancorp (NASDAQ:PMBC) is trading with a trailing P/E of 21.5x, which is higher than the industry average of 17.5x. While this makes PMBC 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 break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for Pacific Mercantile Bancorp
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 PMBC
Price-Earnings Ratio = Price per share ÷ Earnings per share
PMBC Price-Earnings Ratio = $9.7 ÷ $0.451 = 21.5x
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 PMBC, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 21.5x, PMBC’s P/E is higher than its industry peers (17.5x). This implies that investors are overvaluing each dollar of PMBC’s earnings. As such, our analysis shows that PMBC represents an over-priced stock.
A few caveats
While our conclusion might prompt you to sell your PMBC shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to PMBC, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with PMBC, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing PMBC to are fairly valued by the market. If this does not hold, there is a possibility that PMBC’s P/E is lower because our peer group is overvalued by the market.
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.
