This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at American Equity Investment Life Holding Company’s (NYSE:AEL) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, American Equity Investment Life Holding’s P/E ratio is 6.31. In other words, at today’s prices, investors are paying $6.31 for every $1 in prior year profit.
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How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for American Equity Investment Life Holding:
P/E of 6.31 = $30.91 ÷ $4.9 (Based on the year to September 2018.)
Is A High P/E 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, American Equity Investment Life Holding grew EPS by a whopping 68% in the last year. And it has bolstered its earnings per share by 1.1% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does American Equity Investment Life Holding’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that American Equity Investment Life Holding has a lower P/E than the average (14.3) P/E for companies in the insurance industry.
This suggests that market participants think American Equity Investment Life Holding will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
Is Debt Impacting American Equity Investment Life Holding’s P/E?
The extra options and safety that comes with American Equity Investment Life Holding’s US$278m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On American Equity Investment Life Holding’s P/E Ratio
American Equity Investment Life Holding has a P/E of 6.3. That’s below the average in the US market, which is 17.1. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.
Of course you might be able to find a better stock than American Equity Investment Life Holding. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.