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Is Quanex Building Products Corporation's (NYSE:NX) High P/E Ratio A Problem For Investors?

Simply Wall St

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Quanex Building Products Corporation's (NYSE:NX), to help you decide if the stock is worth further research. What is Quanex Building Products's P/E ratio? Well, based on the last twelve months it is 31.87. That corresponds to an earnings yield of approximately 3.1%.

Check out our latest analysis for Quanex Building Products

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Quanex Building Products:

P/E of 31.87 = $16.47 ÷ $0.52 (Based on the trailing twelve months to January 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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 Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Quanex Building Products's earnings per share fell by 35% in the last twelve months. But EPS is up 15% over the last 3 years.

How Does Quanex Building Products's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Quanex Building Products has a higher P/E than the average company (18.6) in the building industry.

NYSE:NX Price Estimation Relative to Market, April 8th 2019

That means that the market expects Quanex Building Products will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

So What Does Quanex Building Products's Balance Sheet Tell Us?

Quanex Building Products's net debt equates to 39% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Quanex Building Products's P/E Ratio

Quanex Building Products trades on a P/E ratio of 31.9, which is above the US market average of 18.1. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Quanex Building Products. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 editorial-team@simplywallst.com. 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.