Should You Be Tempted To Sell Norway Royal Salmon AS (OB:NRS) Because Of Its P/E Ratio?

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Norway Royal Salmon AS's (OB:NRS) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Norway Royal Salmon's P/E ratio is 14.51. That is equivalent to an earnings yield of about 6.9%.

Check out our latest analysis for Norway Royal Salmon

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Norway Royal Salmon:

P/E of 14.51 = NOK198 ÷ NOK13.64 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each NOK1 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.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Most would be impressed by Norway Royal Salmon earnings growth of 14% in the last year. And its annual EPS growth rate over 5 years is 19%. With that performance, you might expect an above average P/E ratio.

How Does Norway Royal Salmon's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (14.2) for companies in the food industry is roughly the same as Norway Royal Salmon's P/E.

Its P/E ratio suggests that Norway Royal Salmon shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

Norway Royal Salmon's Balance Sheet

Norway Royal Salmon has net debt worth just 5.3% of its market capitalization. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Norway Royal Salmon's P/E Ratio

Norway Royal Salmon's P/E is 14.5 which is about average (13.5) in the NO market. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Norway Royal Salmon may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.