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What Does Northern Technologies International Corporation's (NASDAQ:NTIC) P/E Ratio Tell You?

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Northern Technologies International Corporation's (NASDAQ:NTIC), to help you decide if the stock is worth further research. What is Northern Technologies International's P/E ratio? Well, based on the last twelve months it is 24.13. In other words, at today's prices, investors are paying $24.13 for every $1 in prior year profit.

See our latest analysis for Northern Technologies International

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Northern Technologies International:

P/E of 24.13 = USD13.07 ÷ USD0.54 (Based on the year to November 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each USD1 of company earnings. 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'.

Does Northern Technologies International Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (20.9) for companies in the chemicals industry is lower than Northern Technologies International's P/E.

NasdaqGM:NTIC Price Estimation Relative to Market, February 26th 2020
NasdaqGM:NTIC Price Estimation Relative to Market, February 26th 2020

Its relatively high P/E ratio indicates that Northern Technologies International shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Northern Technologies International saw earnings per share decrease by 31% last year. But it has grown its earnings per share by 2.7% per year over the last five years.

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

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

So What Does Northern Technologies International's Balance Sheet Tell Us?

Since Northern Technologies International holds net cash of US$7.1m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Northern Technologies International's P/E Ratio

Northern Technologies International has a P/E of 24.1. That's higher than the average in its market, which is 17.2. Falling earnings per share is probably keeping traditional 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Northern Technologies International. 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.