Nationstar Mortgage Holdings Inc (NYSE:NSM) trades with a trailing P/E of 9x, which is lower than the industry average of 21.1x. While NSM might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View our latest analysis for Nationstar Mortgage Holdings
What you need to know about 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. 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 NSM
Price-Earnings Ratio = Price per share ÷ Earnings per share
NSM Price-Earnings Ratio = $17.15 ÷ $1.915 = 9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to NSM, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 9x, NSM’s P/E is lower than its industry peers (21.1x). This implies that investors are undervaluing each dollar of NSM’s earnings. Therefore, according to this analysis, NSM is an under-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to buy NSM immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to NSM, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with NSM, 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 NSM to are fairly valued by the market. If this does not hold true, NSM’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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.