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Despite Its High P/E Ratio, Is Hannover Rück SE (FRA:HNR1) Still Undervalued?

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Simply Wall St
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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Hannover Rück SE's (FRA:HNR1) P/E ratio to inform your assessment of the investment opportunity. Hannover Rück has a P/E ratio of 15.24, based on the last twelve months. That is equivalent to an earnings yield of about 6.6%.

See our latest analysis for Hannover Rück

How Do I Calculate Hannover Rück's Price To Earnings Ratio?

The formula for P/E is:

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

Or for Hannover Rück:

P/E of 15.24 = €133.9 ÷ €8.79 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Most would be impressed by Hannover Rück earnings growth of 11% in the last year. And it has bolstered its earnings per share by 3.4% per year over the last five years. This could arguably justify a relatively high P/E ratio. In contrast, EPS has decreased by 2.7%, annually, over 3 years.

How Does Hannover Rück's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Hannover Rück has a higher P/E than the average (13.4) P/E for companies in the insurance industry.

DB:HNR1 Price Estimation Relative to Market, April 19th 2019
DB:HNR1 Price Estimation Relative to Market, April 19th 2019

That means that the market expects Hannover Rück will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors 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

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Hannover Rück's Balance Sheet Tell Us?

Hannover Rück has net debt worth just 3.2% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Hannover Rück's P/E Ratio

Hannover Rück trades on a P/E ratio of 15.2, which is below the DE market average of 19.7. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' 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 Hannover Rück. 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).

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.

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. Thank you for reading.