National Holdings Corporation (NASDAQ:NHLD) is currently trading at a trailing P/E of 8.6x, which is lower than the industry average of 18.8x. While NHLD 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 break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for National Holdings
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for NHLD
Price per share = 2.47
Earnings per share = 0.289
∴ Price-Earnings Ratio = 2.47 ÷ 0.289 = 8.6x
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. Ultimately, our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to NHLD, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
At 8.6x, NHLD’s P/E is lower than its industry peers (18.8x). This implies that investors are undervaluing each dollar of NHLD’s earnings. As such, our analysis shows that NHLD represents an under-priced stock.
A few caveats
While our conclusion might prompt you to buy NHLD immediately, there are two important assumptions you should be aware of. The first is that our peer group actually contains companies that are similar to NHLD. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you inadvertently compared lower risk firms with NHLD, then investors would naturally value NHLD at a lower price since it is a riskier investment. Similarly, if you accidentally compared higher growth firms with NHLD, investors would also value NHLD at a lower price since it is a lower growth investment. Both scenarios would explain why NHLD has a lower P/E ratio than its peers. The second assumption that must hold true is that the stocks we are comparing NHLD to are fairly valued by the market. If this assumption does not hold true, NHLD’s lower P/E ratio may be because firms in our peer group are being overvalued by the market.
What this means for you:
Are you a shareholder? You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to NHLD. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision.
Are you a potential investor? If NHLD has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on National Holdings for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.