Meridian Bancorp Inc (NASDAQ:EBSB) is trading with a trailing P/E of 21.2x, which is lower than the industry average of 21.9x. While EBSB might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, 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 Meridian Bancorp
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 EBSB
Price-Earnings Ratio = Price per share ÷ Earnings per share
EBSB Price-Earnings Ratio = $18.85 ÷ $0.891 = 21.2x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to EBSB, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. EBSB’s P/E of 21.2x is lower than its industry peers (21.9x), which implies that each dollar of EBSB’s earnings is being undervalued by investors. As such, our analysis shows that EBSB represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy EBSB immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to EBSB, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with EBSB, 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 EBSB to are fairly valued by the market. If this does not hold, there is a possibility that EBSB’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on EBSB, 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. 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 urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for EBSB’s future growth? Take a look at our free research report of analyst consensus for EBSB’s outlook.
- Past Track Record: Has EBSB 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 EBSB’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 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.