NewMarket Corporation (NYSE:NEU) trades with a trailing P/E of 20x, which is lower than the industry average of 21.2x. While NEU 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. In this article, 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 NewMarket
What you need to know about 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 NEU
Price-Earnings Ratio = Price per share ÷ Earnings per share
NEU Price-Earnings Ratio = $392.53 ÷ $19.587 = 20x
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 NEU, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. NEU’s P/E of 20x is lower than its industry peers (21.2x), which implies that each dollar of NEU’s earnings is being undervalued by investors. As such, our analysis shows that NEU represents an under-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that NEU is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to NEU. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with NEU, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing NEU to are fairly valued by the market. If this does not hold true, NEU’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.