Enterprise Bancorp Stock Remains A Great Bargain (NASDAQ:EBTC)

In late 2020, I recommended purchasing Enterprise Bancorp (NASDAQ:EBTC) for its high-quality business model and its cheap valuation back then. Since my article, the stock has outperformed the broad market by a wide margin, as it has rallied 29% (vs. +11% of the S&P 500). Nevertheless, Enterprise Bancorp remains a great bargain. The bank is currently enjoying a strong tailwind thanks to rising interest rates while it is also trading at a nearly 10-year low trailing price-to-earnings ratio of 10.1. Therefore, those who have not purchased the stock in recent years still have the opportunity to initiate a stake at an attractive entry point.

Business overview

Enterprise Bancorp is a regional bank with 27 branches in Massachusetts and Southern New Hampshire. It has a much simpler business model than the well-known large-cap banks and offers commercial, residential and consumer loan products, deposit products and cash management services.

Due to its “boring” business model and its small market capitalization ($428 million), Enterprise Bancorp passes under the radar of most investors. However, it is exceptionally well managed and hence investors should put the stock on their radar. While many banks tend to somewhat compromise the quality of their loans in order to grow aggressively during boom times, Enterprise Bancorp is laser focused on the quality of its loans. As a result, it has proved one of the most resilient banks to recessions in the investing universe.

To be sure, in the Great Recession, when most banks incurred excessive losses and cut their dividends, Enterprise Bancorp grew its earnings per share by an impressive 37%. Thanks to its strong business performance, its stock price dipped only 3% in that crisis and hence its shareholders did not feel the impact of the Great Recession.

Enterprise Bancorp has proved resilient once again throughout the coronavirus crisis. The bank incurred just a 9% decrease in its earnings per share in 2020 and has already fully recovered from the downturn, with record earnings per share of $3.52 in 2022. It is also remarkable that Enterprise Bancorp has remained profitable in every single quarter since its formation, i.e., for 133 consecutive quarters. This unparalleled consistency is a testament to the high-quality business model of the bank.

During the last decade, Enterprise Bancorp has grown its earnings per share in all but two years, at an 11.1% average annual rate. This is certainly a great performance record, especially given the consistency of the bank and its exceptionally low risk during recessions.

Moreover, Enterprise Bancorp has promising growth prospects ahead. Since the onset of the pandemic, the company has opened three new branches. The opening of three new branches is almost negligible for most banks but it is certainly significant for Enterprise Bancorp, as it corresponds to a 12.5% increase in the number of branches in the last three years.

Furthermore, just like most banks, Enterprise Bancorp currently enjoys a strong tailwind thanks to the favorable environment of rising interest rates. Interest rates remained depressed between 2008 and 2021 but the Fed has begun to raise them aggressively since last year in order to restore inflation to its normal range. Higher interest rates greatly enhance the net interest margin of banks, i.e., the difference between the interest rate charged on loans minus the interest rate paid on deposits.

The positive effect of high interest rates was evident in the latest earnings report of Enterprise Bancorp. In the fourth quarter, the bank enhanced its net interest margin from 3.61% to 3.81% and grew its core loans by 13% over the prior year’s quarter. As a result, the company grew its net interest income 18% and its earnings per share 12%. In addition, Enterprise Bancorp achieved all-time high earnings per share of $3.52 in 2022. Thanks to rising interest rates and some lag between the prevailing level of interest rates and the net interest margin of the bank, earnings per share are likely to grow significantly this year, to a new all-time high.

Valuation

As mentioned above, Enterprise Bancorp has rallied 29% since my article in late 2020. Nevertheless, it is still trading at a trailing price-to-earnings ratio of only 10.1. This earnings multiple is much lower than the 10-year average price-to-earnings ratio of 13.9 of the stock.

The cheap valuation level has resulted primarily from high inflation, which has significantly reduced the present value of future earnings. However, the Fed has made it clear that it will exhaust its means to restore inflation to its long-term target of 2%. Its aggressive policy has already begun to bear fruit, as inflation has decreased in every month since it peaked last summer. Whenever inflation approaches the long-term target of the central bank, the valuation of Enterprise Bancorp is likely to revert to its historical average level. This means that the stock has 38% upside potential (=13.9/10.1 – 1) merely thanks to the expected normalization of its valuation in the upcoming years.

Dividend

Enterprise Bancorp has raised its dividend for 29 consecutive years. As this period includes the Great Recession, which was the fiercest financial crisis of the last century, and the coronavirus crisis, the dividend growth streak of the bank is undoubtedly admirable.

Enterprise Bancorp is currently offering a 2.6% dividend yield. This yield is probably unappealing for most income-oriented investors but it is nearly double the 1.5% dividend yield of the S&P 500. Moreover, the bank has grown its dividend by 9.0% per year on average over the last five years. Given also the exceptionally low payout ratio of only 19%, the bank has ample room to continue raising its dividend at a fast pace for many more years. Therefore, the future dividend hikes are likely to compensate investors for the somewhat low current yield.

It is also important to note that the 2.6% dividend yield of Enterprise Bancorp is a nearly 10-year high dividend yield for the stock. This is probably just another signal that the stock is cheaply valued right now. Overall, investors are given the opportunity to buy this high-quality bank at a nearly 10-year low price-to-earnings ratio, with a nearly 10-year high dividend yield.

Final thoughts

Enterprise Bancorp is an exceptionally well managed bank, with a solid performance record and proven resilient to recessions. The company currently enjoys a tailwind thanks to rising interest rates while the stock is trading at an exceptionally cheap valuation level, mostly due to high inflation. Whenever inflation subsides, Enterprise Bancorp is likely to revert towards its historical valuation level and thus it will highly reward patient investors.