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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to NACCO Industries, Inc.'s (NYSE:NC), to help you decide if the stock is worth further research. What is NACCO Industries's P/E ratio? Well, based on the last twelve months it is 8.32. That is equivalent to an earnings yield of about 12%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for NACCO Industries:
P/E of 8.32 = $49.92 ÷ $6 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It's nice to see that NACCO Industries grew EPS by a stonking 45% in the last year. And earnings per share have improved by 4.4% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Does NACCO Industries Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that NACCO Industries has a lower P/E than the average (12.7) 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. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting NACCO Industries's P/E?
With net cash of US$67m, NACCO Industries has a very strong balance sheet, which may be important for its business. Having said that, at 19% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On NACCO Industries's P/E Ratio
NACCO Industries's P/E is 8.3 which is below average (17.5) in the US market. 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 have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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. Thank you for reading.