It's been a strong day for Nu. Its shares are now trading at $12.18, marking a 3.8% change since the previous market close. An analyst favorite, the Diversified Financial company has a rating of buy. But could the market and the analyst community be overvaluing this stock?
The first step in determining whether a stock is overvalued is to check its price to book (P/B) ratio. This is perhaps the most basic measure of a company's valuation, which is its market value divided by its book value. Book value refers to the sum of all of the company's assets minus its liabilities -- you can also think of it as the company's equity value.
Traditionally, value investors would look for companies with a ratio of less than 1 (meaning that the market value was smaller than the company's book value), but such opportunities are very rare these days. So we tend to look for company's whose valuations are less than their sector and market average. The P/B ratio for Nu is 8.56, compared to its sector average of 1.58 and the S&P 500's average P/B of 2.95.
Modernly, the most common metric for valuing a company is its Price to Earnings (P/E) ratio. It's simply today's stock price of 12.18 divided by either its trailing or forward earnings, which for Nu are $0.27 and $0.65 respectively. Based on these values, the company's trailing P/E ratio is 45.1 and its forward P/E ratio is 18.7. By way of comparison, the average P/E ratio of the Finance sector is 12.38 and the average P/E ratio of the S&P 500 is 15.97.
If a company is overvalued in terms of its earnings, we also need to check if it has the ability to meet its financial obligations. One way to check this is via the so called Quick Ratio or Acid Test, which is the sum of its current assets, inventory, and prepaid expenses divided by its current liabilities. Nu's Quick ratio is 0.696, which indicates that that it does not have the liquidity necessary to meet its current liabilities.
When we had up all the inflows and outflows of cash, including payments to creditors, we obtain Nu's levered free cash flow of $755.57 Million. This represents the money left over from the company's operations that is available for reinvestment in the business, or for paying out to equity investors in the form of a dividend. Despite its positive cash flows, Nu does not currently pay a dividend.
Shares of Nu appear to be overvalued at today's prices — despite the positive outlook from analysts. But sometimes stocks with inflated valuations turn out to be strong performances for years, and even decades, such as Amazon. So be sure to do your own due diligence if you are interested in taking a long position in NU.
