NewRiver REIT plc (LSE:NRR) trades with a trailing P/E of 21.9x, which is lower than the industry average of 13.8x. While this makes NRR appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for NewRiver REIT
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 pound of the company’s earnings.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for NRR
Price per share = 3.39
Earnings per share = 0.155
∴ Price-Earnings Ratio = 3.39 ÷ 0.155 = 21.9x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as NRR, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 21.9x, NRR’s P/E is higher than its industry peers (13.8x). This implies that investors are overvaluing each dollar of NRR’s earnings. Therefore, according to this analysis, NRR is an over-priced stock.
Assumptions to watch out for
However, before you rush out to buy NRR, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to NRR. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with NRR, then investors would naturally value NRR at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with NRR, investors would also value NRR at a lower price since it is a lower growth investment. Both scenarios would explain why NRR has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing NRR to are fairly valued by the market. If this assumption does not hold true, NRR’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to NRR. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If NRR has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on NewRiver REIT for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.