I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Nordson Corporation (NASDAQ:NDSN) trades with a trailing P/E of 19.6x, which is lower than the industry average of 21x. While this makes NDSN 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 break down what the P/E ratio is, how to interpret it and what to watch out for.
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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 NDSN
Price-Earnings Ratio = Price per share ÷ Earnings per share
NDSN Price-Earnings Ratio = $125.55 ÷ $6.404 = 19.6x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to NDSN, 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 NDSN’s P/E of 19.6 is lower than its industry peers (21), it means that investors are paying less for each dollar of NDSN’s earnings. This multiple is a median of profitable companies of 25 Machinery companies in US including Eco Energy Tech Asia, EnPro Industries and Hebron Technology. You can think of it like this: the market is suggesting that NDSN is a weaker business than the average comparable company.
A few caveats
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to NDSN. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with NDSN, 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 NDSN to are fairly valued by the market. If this does not hold true, NDSN’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
Since you may have already conducted your due diligence on NDSN, the undervaluation of the stock may mean it is a good time to top up on your current holdings. But at the end of the day, keep in mind that relative valuation relies heavily on critical assumptions I’ve outlined 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for NDSN’s future growth? Take a look at our free research report of analyst consensus for NDSN’s outlook.
- Past Track Record: Has NDSN 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 NDSN’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 email@example.com.