The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Nordstrom, Inc.'s (NYSE:JWN) P/E ratio to inform your assessment of the investment opportunity. Nordstrom has a price to earnings ratio of 11.63, based on the last twelve months. That corresponds to an earnings yield of approximately 8.6%.
Check out our latest analysis for Nordstrom
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Nordstrom:
P/E of 11.63 = $40.73 ÷ $3.50 (Based on the year to November 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Nordstrom'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. If you look at the image below, you can see Nordstrom has a lower P/E than the average (13.1) in the multiline retail industry classification.
Its relatively low P/E ratio indicates that Nordstrom shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Nordstrom increased earnings per share by a whopping 26% last year. And it has improved its earnings per share by 22% per year over the last three years. I'd therefore be a little surprised if its P/E ratio was not relatively high. In contrast, EPS has decreased by 1.8%, annually, over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Nordstrom's Balance Sheet
Nordstrom has net debt equal to 35% of its market cap. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Nordstrom's P/E Ratio
Nordstrom's P/E is 11.6 which is below average (18.9) in the US market. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Nordstrom 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).
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.
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