Nathan’s Famous Inc (NASDAQ:NATH) trades with a trailing P/E of 40.3x, which is higher than the industry average of 24.6x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. See our latest analysis for Nathan’s Famous
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key 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 NATH
Price-Earnings Ratio = Price per share ÷ Earnings per share
NATH Price-Earnings Ratio = $72.05 ÷ $1.789 = 40.3x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to NATH, such as capital structure and profitability. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. NATH’s P/E of 40.3x is higher than its industry peers (24.6x), which implies that each dollar of NATH’s earnings is being overvalued by investors. As such, our analysis shows that NATH represents an over-priced stock.
A few caveats
However, before you rush out to sell your NATH shares, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to NATH. 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 NATH, 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 NATH to are fairly valued by the market. If this is violated, NATH’s P/E may be lower than its peers as they are actually overvalued by investors.
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.