This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Nasdaq, Inc.'s (NASDAQ:NDAQ) P/E ratio to inform your assessment of the investment opportunity. What is Nasdaq's P/E ratio? Well, based on the last twelve months it is 28.23. That corresponds to an earnings yield of approximately 3.5%.
Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
How Do I Calculate Nasdaq's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Nasdaq:
P/E of 28.23 = $90.36 ÷ $3.2 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Nasdaq saw earnings per share decrease by 28% last year. But it has grown its earnings per share by 3.8% per year over the last five years. And it has shrunk its earnings per share by 1.2% per year over the last three years. This could justify a low P/E.
Does Nasdaq Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Nasdaq has a lower P/E than the average (32.1) in the capital markets industry classification.
Its relatively low P/E ratio indicates that Nasdaq shareholders think it will struggle to do as well as other companies in its industry classification. 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
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
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.
Nasdaq's Balance Sheet
Nasdaq has net debt worth 23% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Nasdaq's P/E Ratio
Nasdaq trades on a P/E ratio of 28.2, which is above the US market average of 17.8. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
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.