Does NL Industries Inc’s (NYSE:NL) PE Ratio Warrant A Buy?
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
NL Industries Inc (NYSE:NL) is currently trading at a trailing P/E of 7.6x, which is lower than the industry average of 19.8x. While this makes NL 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 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 NL Industries
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. 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 NL
Price-Earnings Ratio = Price per share ÷ Earnings per share
NL Price-Earnings Ratio = $5.94 ÷ $0.784 = 7.6x
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 NL, 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 NL’s P/E of 7.6 is lower than its industry peers (19.8), it means that investors are paying less for each dollar of NL’s earnings. This multiple is a median of profitable companies of 24 Commercial Services companies in US including Pointer Telocation, Covanta Holding and McGrath RentCorp. You can think of it like this: the market is suggesting that NL is a weaker business than the average comparable company.
Assumptions to watch out for
Before you jump to conclusions it is important to realise that our assumptions rests on two assertions. Firstly, our peer group contains companies that are similar to NL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with NL, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing NL to are fairly valued by the market. If this is violated, NL’s P/E may be lower than its peers as they are actually overvalued by investors.
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 add more of NL to your portfolio. 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:
Future Outlook: What are well-informed industry analysts predicting for NL’s future growth? Take a look at our free research report of analyst consensus for NL’s outlook.
Past Track Record: Has NL 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 NL’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 past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.