Despite Its High P/E Ratio, Is Old Dominion Freight Line, Inc. (NASDAQ:ODFL) Still Undervalued?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Old Dominion Freight Line, Inc.’s (NASDAQ:ODFL) P/E ratio to inform your assessment of the investment opportunity. What is Old Dominion Freight Line’s P/E ratio? Well, based on the last twelve months it is 24.08. That corresponds to an earnings yield of approximately 4.2%.

View our latest analysis for Old Dominion Freight Line

How Do You Calculate Old Dominion Freight Line’s P/E Ratio?

The formula for price to earnings is:

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

Or for Old Dominion Freight Line:

P/E of 24.08 = $188.22 ÷ $7.82 (Based on the trailing twelve months to September 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Old Dominion Freight Line Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (19.6) for companies in the transportation industry is lower than Old Dominion Freight Line’s P/E.

NasdaqGS:ODFL Price Estimation Relative to Market, December 23rd 2019
NasdaqGS:ODFL Price Estimation Relative to Market, December 23rd 2019

Old Dominion Freight Line’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Old Dominion Freight Line had pretty flat EPS growth in the last year. But it has grown its earnings per share by 22% per year over the last five years.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Old Dominion Freight Line’s Balance Sheet

The extra options and safety that comes with Old Dominion Freight Line’s US$277m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Old Dominion Freight Line’s P/E Ratio

Old Dominion Freight Line trades on a P/E ratio of 24.1, which is above its market average of 18.9. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

Investors should be looking to buy stocks that the market is wrong about. 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.

You might be able to find a better buy than Old Dominion Freight Line. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.

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. Thank you for reading.