Malvern Bancorp Inc (NASDAQ:MLVF) trades with a trailing P/E of 31.9x, which is higher than the industry average of 22.8x. While MLVF 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 Malvern Bancorp

Breaking down the Price-Earnings ratio

The P/E ratio is one of many ratios used in relative valuation. 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 MLVF

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

MLVF Price-Earnings Ratio = $26 ÷ $0.815 = 31.9x

The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful 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 MLVF, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. MLVF’s P/E of 31.9x is higher than its industry peers (22.8x), which implies that each dollar of MLVF’s earnings is being overvalued by investors. Therefore, according to this analysis, MLVF is an over-priced stock.

Assumptions to be aware of

However, before you rush out to sell your MLVF shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to MLVF. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with MLVF, 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 MLVF to are fairly valued by the market. If this does not hold, there is a possibility that MLVF’s P/E is lower because our peer group is overvalued by the market.

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.