This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use NACCO Industries, Inc.'s (NYSE:NC) P/E ratio to inform your assessment of the investment opportunity. What is NACCO Industries's P/E ratio? Well, based on the last twelve months it is 7.38. That corresponds to an earnings yield of approximately 13.5%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for NACCO Industries:
P/E of 7.38 = $46.93 ÷ $6.36 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does NACCO Industries's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that NACCO Industries has a lower P/E than the average (9.9) P/E for companies in the oil and gas industry.
NACCO Industries's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
It's nice to see that NACCO Industries grew EPS by a stonking 31% in the last year. And its annual EPS growth rate over 5 years is 14%. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
NACCO Industries's Balance Sheet
NACCO Industries has net cash of US$108m. This is fairly high at 33% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On NACCO Industries's P/E Ratio
NACCO Industries has a P/E of 7.4. That's below the average in the US market, which is 18.3. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than NACCO Industries. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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