Don't Sell National Australia Bank Limited (ASX:NAB) Before You Read This

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how National Australia Bank Limited's (ASX:NAB) P/E ratio could help you assess the value on offer. Based on the last twelve months, National Australia Bank's P/E ratio is 14.25. That means that at current prices, buyers pay A$14.25 for every A$1 in trailing yearly profits.

See 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 14.25 = AUD25.50 ÷ AUD1.79 (Based on the year to September 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each AUD1 of company earnings. 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.

Does National Australia Bank Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, National Australia Bank has a higher P/E than the average company (11.6) in the banks industry.

Its relatively high P/E ratio indicates that National Australia Bank shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

National Australia Bank shrunk earnings per share by 17% over the last year. And EPS is down 3.5% a year, over the last 5 years. This could justify a pessimistic P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

So What Does National Australia Bank's Balance Sheet Tell Us?

National Australia Bank has net debt worth a very significant 161% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On National Australia Bank's P/E Ratio

National Australia Bank's P/E is 14.3 which is below average (18.7) in the AU market. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.

Investors have an opportunity when market expectations about a stock are wrong. 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 be able to find a better stock than National Australia Bank. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.