Does National Australia Bank Limited’s (ASX:NAB) P/E Ratio Signal A Buying Opportunity?

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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 National Australia Bank Limited’s (ASX:NAB) P/E ratio to inform your assessment of the investment opportunity. National Australia Bank has a P/E ratio of 12.57, based on the last twelve months. That means that at current prices, buyers pay A$12.57 for every A$1 in trailing yearly profits.

View our latest analysis for National Australia Bank

How Do You Calculate National Australia Bank’s P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for National Australia Bank:

P/E of 12.57 = A$26.94 ÷ A$2.14 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

National Australia Bank’s earnings per share fell by 5.6% in the last twelve months. And EPS is down 2.4% a year, over the last 5 years. So you wouldn’t expect a very high P/E.

How Does National Australia Bank’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 National Australia Bank has a lower P/E than the average (13.7) P/E for companies in the banks industry.

ASX:NAB Price Estimation Relative to Market, June 24th 2019
ASX:NAB Price Estimation Relative to Market, June 24th 2019

National Australia Bank’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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

The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

National Australia Bank’s Balance Sheet

Net debt totals a substantial 153% of National Australia Bank’s market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.

The Bottom Line On National Australia Bank’s P/E Ratio

National Australia Bank trades on a P/E ratio of 12.6, which is below the AU market average of 16.2. When you consider that the company has significant debt, and didn’t grow EPS last year, it isn’t surprising that the market has muted expectations.

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.’ So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

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 editorial-team@simplywallst.com. 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.