NOV Inc.'s (NYSE:NOV) Shares Lagging The Market But So Is The Business

With a price-to-earnings (or "P/E") ratio of 6.7x NOV Inc. (NYSE:NOV) may be sending very bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 19x and even P/E's higher than 33x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

Recent times have been pleasing for NOV as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as depressed as NOV's is when the company's growth is on track to lag the market decidedly.

Retrospectively, the last year delivered an exceptional 152% gain to the company's bottom line. Still, EPS has barely risen at all from three years ago in total, which is not ideal. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 7.4% per annum over the next three years. That's not great when the rest of the market is expected to grow by 10% per year.

In light of this, it's understandable that NOV's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of NOV's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Before you take the next step, you should know about the 2 warning signs for NOV (1 can't be ignored!) that we have uncovered.

If you're unsure about the strength of NOV's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.