Nathan’s Famous Inc (NASDAQ:NATH) is trading with a trailing P/E of 122.3x, which is higher than the industry average of 23.4x. While this makes NATH appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Nathan’s Famous
Breaking down the P/E ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for NATH
Price-Earnings Ratio = Price per share ÷ Earnings per share
NATH Price-Earnings Ratio = $87.6 ÷ $0.716 = 122.3x
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 want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as NATH, 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 NATH’s P/E of 122.3x is higher than its industry peers (23.4x), it means that investors are paying more than they should for each dollar of NATH’s earnings. Therefore, according to this analysis, NATH is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that NATH should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to NATH, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with NATH, 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 NATH to are fairly valued by the market. If this does not hold true, NATH’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in NATH. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
- Financial Health: Is NATH’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has NATH been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of NATH’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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.