Preferred Bank (NASDAQ:PFBC) trades with a trailing P/E of 18.5x, which is higher than the industry average of 16.6x. While PFBC 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Preferred Bank
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 PFBC
Price-Earnings Ratio = Price per share ÷ Earnings per share
PFBC Price-Earnings Ratio = $58.78 ÷ $3.17 = 18.5x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as PFBC, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since PFBC’s P/E of 18.5x is higher than its industry peers (16.6x), it means that investors are paying more than they should for each dollar of PFBC’s earnings. Therefore, according to this analysis, PFBC is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your PFBC shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to PFBC, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with PFBC, 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 PFBC to are fairly valued by the market. If this is violated, PFBC’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 PFBC. 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 PFBC 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 Preferred Bank 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.