UMB Financial Corporation (NASDAQ:UMBF) is currently trading at a trailing P/E of 19.5x, which is higher than the industry average of 16.7x. While UMBF 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. Check out our latest analysis for UMB Financial
Breaking down the Price-Earnings 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 UMBF
Price-Earnings Ratio = Price per share ÷ Earnings per share
UMBF Price-Earnings Ratio = $73.03 ÷ $3.747 = 19.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 UMBF, 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. Since UMBF’s P/E of 19.5x is higher than its industry peers (16.7x), it means that investors are paying more than they should for each dollar of UMBF’s earnings. Therefore, according to this analysis, UMBF is an over-priced stock.
A few caveats
Before you jump to the conclusion that UMBF should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to UMBF. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with UMBF, 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 UMBF to are fairly valued by the market. If this does not hold true, UMBF’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? 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 UMBF. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.