National Presto Industries Inc (NYSE:NPK) is currently trading at a trailing P/E of 17.7x, which is lower than the industry average of 22.7x. While this makes NPK 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. Check out our latest analysis for National Presto Industries
Demystifying the P/E ratio
P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for NPK
Price-Earnings Ratio = Price per share ÷ Earnings per share
NPK Price-Earnings Ratio = $112.4 ÷ $6.339 = 17.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to NPK, 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. Since NPK’s P/E of 17.7x is lower than its industry peers (22.7x), it means that investors are paying less than they should for each dollar of NPK’s earnings. As such, our analysis shows that NPK represents an under-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to buy NPK immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to NPK. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with NPK, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing NPK to are fairly valued by the market. If this is violated, NPK’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to NPK. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. 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 urge you to complete your research by taking a look at the following:
- Financial Health: Is NPK’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
- Past Track Record: Has NPK 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 NPK’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 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.