I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Northern Trust Corporation (NASDAQ:NTRS).
Northern Trust Corporation (NASDAQ:NTRS) is trading with a trailing P/E of 19x, which is higher than the industry average of 15.9x. While this makes NTRS appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View out our latest analysis for Northern Trust
Breaking down the Price-Earnings ratio
P/E is often used for relative valuation since earnings power is a chief driver of investment value. 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 NTRS
Price per share = $103.4
Earnings per share = $5.446
∴ Price-Earnings Ratio = $103.4 ÷ $5.446 = 19x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with 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 NTRS, 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.
At 19x, NTRS’s P/E is higher than its industry peers (15.9x). This implies that investors are overvaluing each dollar of NTRS’s earnings. This multiple is a median of profitable companies of 25 Capital Markets companies in US including Modern Technology, Neon Capital and Oracle Healthcare Acquisition. Therefore, according to this analysis, NTRS is an over-priced stock.
A few caveats
Before you jump to the conclusion that NTRS 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 NTRS. 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 NTRS, then NTRS’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 NTRS. In this case, NTRS’s P/E would be higher since investors would also reward NTRS’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing NTRS to are fairly valued by the market. If this does not hold, there is a possibility that NTRS’s P/E is higher because firms in our peer group are being undervalued by the market.
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 NTRS. 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 highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for NTRS’s future growth? Take a look at our free research report of analyst consensus for NTRS’s outlook.
- Past Track Record: Has NTRS 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 NTRS’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.