Here's How P/E Ratios Can Help Us Understand Central Valley Community Bancorp (NASDAQ:CVCY)

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Central Valley Community Bancorp's (NASDAQ:CVCY) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Central Valley Community Bancorp has a P/E ratio of 12.87. That corresponds to an earnings yield of approximately 7.8%.

Check out our latest analysis for Central Valley Community Bancorp

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Central Valley Community Bancorp:

P/E of 12.87 = $19.93 ÷ $1.55 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

It's nice to see that Central Valley Community Bancorp grew EPS by a stonking 32% in the last year. And earnings per share have improved by 13% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.

How Does Central Valley Community Bancorp's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (13) for companies in the banks industry is roughly the same as Central Valley Community Bancorp's P/E.

Its P/E ratio suggests that Central Valley Community Bancorp shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Central Valley Community Bancorp actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Central Valley Community Bancorp's Balance Sheet Tell Us?

Since Central Valley Community Bancorp holds net cash of US$20m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Central Valley Community Bancorp's P/E Ratio

Central Valley Community Bancorp trades on a P/E ratio of 12.9, which is below the US market average of 18. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Central Valley Community Bancorp. So you may wish to see this free collection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.