MainSource Financial Group Inc (NASDAQ:MSFG) trades with a trailing P/E of 20.2x, which is higher than the industry average of 17.8x. While MSFG 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 MainSource Financial Group

Breaking down the P/E ratio

A common ratio used for relative valuation is the P/E ratio. 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 MSFG

Price-Earnings Ratio = Price per share ÷ Earnings per share

MSFG Price-Earnings Ratio = $39.83 ÷ $1.969 = 20.2x

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 MSFG, 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 20.2x, MSFG’s P/E is higher than its industry peers (17.8x). This implies that investors are overvaluing each dollar of MSFG’s earnings. As such, our analysis shows that MSFG represents an over-priced stock.

Assumptions to be aware of

While our conclusion might prompt you to sell your MSFG shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to MSFG, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with MSFG, 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 MSFG to are fairly valued by the market. If this is violated, MSFG’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.