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Despite Its High P/E Ratio, Is National Express Group PLC (LON:NEX) Still Undervalued?

Simply Wall St

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use National Express Group PLC's (LON:NEX) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, National Express Group's P/E ratio is 15.54. That corresponds to an earnings yield of approximately 6.4%.

Check out our latest analysis for National Express Group

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for National Express Group:

P/E of 15.54 = £4.13 ÷ £0.27 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each £1 the company has earned over the last year. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

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. 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.

National Express Group saw earnings per share improve by -8.4% last year. And earnings per share have improved by 19% annually, over the last five years.

How Does National Express Group's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, National Express Group has a higher P/E than the average company (10.8) in the transportation industry.

LSE:NEX Price Estimation Relative to Market, May 9th 2019

That means that the market expects National Express Group will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. 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 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.

National Express Group's Balance Sheet

National Express Group has net debt equal to 48% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.

The Verdict On National Express Group's P/E Ratio

National Express Group trades on a P/E ratio of 15.5, which is fairly close to the GB market average of 16.4. With modest debt and some recent earnings growth, it seems likely the market expects a steady performance going forward.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: National Express Group 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.