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Despite Its High P/E Ratio, Is AIA Group Limited (HKG:1299) Still Undervalued?

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use AIA Group Limited's (HKG:1299) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, AIA Group has a P/E ratio of 26.91. That corresponds to an earnings yield of approximately 3.7%.

Check out our latest analysis for AIA Group

How Do I Calculate AIA Group's Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for AIA Group:

P/E of 26.91 = HK$10.19 (Note: this is the share price in the reporting currency, namely, USD ) ÷ HK$0.38 (Based on the year to June 2019.)

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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does AIA Group's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that AIA Group has a higher P/E than the average (9.9) P/E for companies in the insurance industry.

SEHK:1299 Price Estimation Relative to Market, November 27th 2019

That means that the market expects AIA Group will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

AIA Group increased earnings per share by 3.2% last year. And it has bolstered its earnings per share by 13% per year over the last five years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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.

How Does AIA Group's Debt Impact Its P/E Ratio?

With net cash of US$68b, AIA Group has a very strong balance sheet, which may be important for its business. Having said that, at 56% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On AIA Group's P/E Ratio

AIA Group trades on a P/E ratio of 26.9, which is above its market average of 10.3. Earnings improved over the last year. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: AIA Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

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. Thank you for reading.