Independence Holding Company (NYSE:IHC) is currently trading at a trailing P/E of 12x, which is lower than the industry average of 14.2x. While this makes IHC appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View our latest analysis for Independence Holding
Breaking down the Price-Earnings 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 IHC
Price-Earnings Ratio = Price per share ÷ Earnings per share
IHC Price-Earnings Ratio = $34.7 ÷ $2.889 = 12x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as IHC, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. At 12x, IHC’s P/E is lower than its industry peers (14.2x). This implies that investors are undervaluing each dollar of IHC’s earnings. Therefore, according to this analysis, IHC is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy IHC, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to IHC. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with IHC, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing IHC to are fairly valued by the market. If this does not hold true, IHC’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
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 IHC. 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:
- Future Outlook: What are well-informed industry analysts predicting for IHC’s future growth? Take a look at our free research report of analyst consensus for IHC’s outlook.
- Past Track Record: Has IHC 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 IHC’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.