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Despite Its High P/E Ratio, Is Napier Port Holdings Limited (NZSE:NPH) Still Undervalued?

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Napier Port Holdings Limited's (NZSE:NPH) P/E ratio to inform your assessment of the investment opportunity. What is Napier Port Holdings's P/E ratio? Well, based on the last twelve months it is 55.44. That is equivalent to an earnings yield of about 1.8%.

View our latest analysis for Napier Port Holdings

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Napier Port Holdings:

P/E of 55.44 = NZ$3.150 ÷ NZ$0.057 (Based on the year to September 2019.)

(Note: the above calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each NZ$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Napier Port Holdings Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Napier Port Holdings has a higher P/E than the average company (25.2) in the infrastructure industry.

NZSE:NPH Price Estimation Relative to Market, March 8th 2020

Napier Port Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Napier Port Holdings shrunk earnings per share by 64% over the last year. And EPS is down 38% a year, over the last 5 years. This might lead to muted expectations.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

So What Does Napier Port Holdings's Balance Sheet Tell Us?

Napier Port Holdings has net cash of NZ$31m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Napier Port Holdings's P/E Ratio

Napier Port Holdings trades on a P/E ratio of 55.4, which is above its market average of 19.5. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.