Why Nathan’s Famous, Inc.’s (NASDAQ:NATH) High P/E Ratio Isn’t Necessarily A Bad Thing
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Nathan’s Famous, Inc.’s (NASDAQ:NATH) P/E ratio to inform your assessment of the investment opportunity. Nathan’s Famous has a P/E ratio of 48.03, based on the last twelve months. That is equivalent to an earnings yield of about 2.1%.
Check out our latest analysis for Nathan’s Famous
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Nathan’s Famous:
P/E of 48.03 = $67.33 ÷ $1.4 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings 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 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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Nathan’s Famous’s earnings per share fell by 22% in the last twelve months. And it has shrunk its earnings per share by 14% per year over the last five years. This could justify a pessimistic P/E.
How Does Nathan’s Famous’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Nathan’s Famous has a higher P/E than the average (16.8) P/E for companies in the hospitality industry.
Nathan’s Famous’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Nathan’s Famous’s P/E?
Nathan’s Famous has net debt worth 28% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Nathan’s Famous’s P/E Ratio
Nathan’s Famous’s P/E is 48 which is above average (16.8) in the US market. 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 should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Nathan’s Famous. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
