Norwegian Finans Holding ASA (OB:NOFI) is currently trading at a trailing P/E of 10.1x, which is higher than the industry average of 9x. While NOFI might seem like a stock to avoid or sell if you own it, 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. See our latest analysis for Norwegian Finans Holding
Demystifying 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 NOFI
Price per share = NOK90.9
Earnings per share = NOK8.988
∴ Price-Earnings Ratio = NOK90.9 ÷ NOK8.988 = 10.1x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against 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 NOFI, 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.
NOFI’s P/E of 10.1x is higher than its industry peers (9x), which implies that each dollar of NOFI’s earnings is being overvalued by investors. Therefore, according to this analysis, NOFI is an over-priced stock.
Assumptions to watch out for
While our conclusion might prompt you to sell your NOFI shares immediately, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to NOFI. If the companies aren’t similar, the difference in P/E might be a result of other factors. For example, if you accidentally compared lower growth firms with NOFI, then NOFI’s P/E would naturally be higher since investors would reward NOFI’s higher growth with a higher price. Alternatively, if you inadvertently compared riskier firms with NOFI, NOFI’s P/E would again be higher since investors would reward NOFI’s lower risk with a higher price as well. The second assumption that must hold true is that the stocks we are comparing NOFI to are fairly valued by the market. If this assumption is violated, NOFI’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 NOFI. 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 NOFI’s future growth? Take a look at our free research report of analyst consensus for NOFI’s outlook.
- Past Track Record: Has NOFI 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 NOFI’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.