The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Boston Private Financial Holdings Inc (NASDAQ:BPFH) is currently trading at a trailing P/E of 57.7x, which is higher than the industry average of 16.2x. While BPFH 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. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Check out our latest analysis for Boston Private Financial Holdings
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. 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 BPFH
Price-Earnings Ratio = Price per share ÷ Earnings per share
BPFH Price-Earnings Ratio = $13.95 ÷ $0.242 = 57.7x
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. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to BPFH, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. Since BPFH’s P/E of 57.7x is higher than its industry peers (16.2x), it means that investors are paying more than they should for each dollar of BPFH’s earnings. This multiple is a median of profitable companies of 25 Banks companies in US including Great Basin Financial, Mercantil Servicios Financieros C.A and CIB Marine Bancshares. Therefore, according to this analysis, BPFH is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your BPFH shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to BPFH. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with BPFH, 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 BPFH to are fairly valued by the market. If this does not hold true, BPFH’s lower P/E ratio may be because firms in our peer group are overvalued by the market.