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CB Financial Services Inc (NASDAQ:CBFV) trades with a trailing P/E of 19.2x, which is higher than the industry average of 17.6x. While this makes CBFV 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. 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. Check out our latest analysis for CB Financial Services
What you need to know about the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 CBFV
Price-Earnings Ratio = Price per share ÷ Earnings per share
CBFV Price-Earnings Ratio = $32.65 ÷ $1.699 = 19.2x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 CBFV, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 19.2x, CBFV’s P/E is higher than its industry peers (17.6x). This implies that investors are overvaluing each dollar of CBFV’s earnings. Therefore, according to this analysis, CBFV is an over-priced stock.
A few caveats
Before you jump to the conclusion that CBFV should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to CBFV, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with CBFV, 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 CBFV to are fairly valued by the market. If this is violated, CBFV’s P/E may be lower than its peers as they are actually overvalued by investors.
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.