HV Bancorp Inc (NASDAQ:HVBC) is trading with a trailing P/E of 59.9x, which is higher than the industry average of 22.6x. While this makes HVBC 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 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 HV Bancorp
Breaking down the Price-Earnings ratio
The P/E ratio is one of many ratios used in relative valuation. 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 HVBC
Price-Earnings Ratio = Price per share ÷ Earnings per share
HVBC Price-Earnings Ratio = $15.16 ÷ $0.253 = 59.9x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to HVBC, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since HVBC’s P/E of 59.9x is higher than its industry peers (22.6x), it means that investors are paying more than they should for each dollar of HVBC’s earnings. As such, our analysis shows that HVBC represents an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your HVBC shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to HVBC, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with HVBC, 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 HVBC to are fairly valued by the market. If this does not hold true, HVBC’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Are you a shareholder? Since you may have already conducted your due diligence on HVBC, the overvaluation of the stock may mean it is a good time to reduce 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.
Are you a potential investor? If you are considering investing in HVBC, basing your decision on the PE metric at one point in time is certainly not sufficient. I recommend you do additional analysis by looking at its intrinsic valuation and using other relative valuation ratios like PEG or EV/EBITDA.
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 HV Bancorp 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.