This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Navitas Limited (ASX:NVT).
Navitas Limited (ASX:NVT) is currently trading at a trailing P/E of 30.4x, which is higher than the industry average of 13.9x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. View out our latest analysis for Navitas
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. 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.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for NVT
Price per share = A$4.38
Earnings per share = A$0.144
∴ Price-Earnings Ratio = A$4.38 ÷ A$0.144 = 30.4x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to NVT, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use below. Since it is expected that similar companies have similar P/E ratios, we can come to some conclusions about the stock if the ratios are different.
NVT’s P/E of 30.4x is higher than its industry peers (13.9x), which implies that each dollar of NVT’s earnings is being overvalued by investors. Therefore, according to this analysis, NVT is an over-priced stock.
A few caveats
Before you jump to the conclusion that NVT should be banished from your portfolio, it is important to realise that our conclusion rests on two important assertions. The first is that our “similar companies” are actually similar to NVT. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you are inadvertently comparing riskier firms with NVT, then NVT’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with NVT. In this case, NVT’s P/E would be higher since investors would also reward NVT’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing NVT to are fairly valued by the market. If this assumption is violated, NVT’s P/E may be higher than its peers because its peers are actually undervalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to NVT. 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. 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 NVT’s future growth? Take a look at our free research report of analyst consensus for NVT’s outlook.
- Past Track Record: Has NVT 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 NVT’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.