Should You Be Tempted To Sell Insperity Inc (NYSE:NSP) Because Of Its PE Ratio?
Insperity Inc (NYSE:NSP) is currently trading at a trailing P/E of 36x, which is higher than the industry average of 22.3x. While this makes NSP appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. 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 Insperity
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for NSP
Price-Earnings Ratio = Price per share ÷ Earnings per share
NSP Price-Earnings Ratio = $72.6 ÷ $2.018 = 36x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as NSP, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. At 36x, NSP’s P/E is higher than its industry peers (22.3x). This implies that investors are overvaluing each dollar of NSP’s earnings. As such, our analysis shows that NSP represents an over-priced stock.
A few caveats
However, before you rush out to sell your NSP shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to NSP, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with NSP, 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 NSP to are fairly valued by the market. If this is violated, NSP’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in NSP. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. 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:
Future Outlook: What are well-informed industry analysts predicting for NSP’s future growth? Take a look at our free research report of analyst consensus for NSP’s outlook.
Past Track Record: Has NSP 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 NSP’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.
