Newtek Business Services Corp (NASDAQ:NEWT) is currently trading at a trailing P/E of 10.4x, which is lower than the industry average of 16.1x. While NEWT might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Newtek Business Services
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 NEWT
Price-Earnings Ratio = Price per share ÷ Earnings per share
NEWT Price-Earnings Ratio = $17.22 ÷ $1.652 = 10.4x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to NEWT, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since NEWT’s P/E of 10.4x is lower than its industry peers (16.1x), it means that investors are paying less than they should for each dollar of NEWT’s earnings. As such, our analysis shows that NEWT represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy NEWT immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to NEWT, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with NEWT, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing NEWT to are fairly valued by the market. If this does not hold, there is a possibility that NEWT’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.