Is American Equity Investment Life Holding Company (NYSE:AEL) A Buy At Its Current PE Ratio?
I am writing today to help inform people who are new to the stock market and want to begin learning the link between American Equity Investment Life Holding Company (NYSE:AEL)’s fundamentals and stock market performance.
American Equity Investment Life Holding Company (NYSE:AEL) is currently trading at a trailing P/E of 12.3x, which is lower than the industry average of 14.3x. While AEL might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for American Equity Investment Life Holding
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for AEL
Price-Earnings Ratio = Price per share ÷ Earnings per share
AEL Price-Earnings Ratio = $35.91 ÷ $2.929 = 12.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to AEL, such as company lifetime and products sold. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since AEL’s P/E of 12.3x is lower than its industry peers (14.3x), it means that investors are paying less than they should for each dollar of AEL’s earnings. Therefore, according to this analysis, AEL is an under-priced stock.
A few caveats
Before you jump to the conclusion that AEL is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to AEL. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with AEL, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing AEL to are fairly valued by the market. If this is violated, AEL’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to AEL. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
Financial Health: Is AEL’s operations financially sustainable? Balance sheets can be hard to analyze, which is why we’ve done it for you. Check out our financial health checks here.
Past Track Record: Has AEL been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of AEL’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass 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.
