Does Nortech Systems Incorporated’s (NSYS) PE Ratio Signal A Selling Opportunity?
Nortech Systems Incorporated (NASDAQ:NSYS) trades with a trailing P/E of 78.4x, which is higher than the industry average of 26.3x. While this makes NSYS 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. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for NSYS
Breaking down the Price-Earnings 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 NSYS
Price-Earnings Ratio = Price per share ÷ Earnings per share
NSYS Price-Earnings Ratio = 3.73 ÷ 0.048 = 78.4x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful 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 NSYS, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since NSYS's P/E of 78.4x is higher than its industry peers (26.3x), it means that investors are paying more than they should for each dollar of NSYS's earnings. Therefore, according to this analysis, NSYS is an over-priced stock.
Assumptions to watch out for
However, before you rush out to sell your NSYS shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to NSYS, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with NSYS, 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 NSYS to are fairly valued by the market. If this does not hold, there is a possibility that NSYS’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? 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 NSYS. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If NSYS has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on Nortech Systems for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn't properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
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.
