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To the annoyance of some shareholders, American National Insurance (NASDAQ:ANAT) shares are down a considerable 32% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 40% drop over twelve months.
All else being equal, a share price drop should make a stock more attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does American National Insurance Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 3.17 that sentiment around American National Insurance isn't particularly high. We can see in the image below that the average P/E (8.6) for companies in the insurance industry is higher than American National Insurance's P/E.
Its relatively low P/E ratio indicates that American National Insurance shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
American National Insurance's earnings made like a rocket, taking off 290% last year. The cherry on top is that the five year growth rate was an impressive 20% per year. So I'd be surprised if the P/E ratio was not above average.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. 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 American National Insurance's Balance Sheet Tell Us?
With net cash of US$719m, American National Insurance has a very strong balance sheet, which may be important for its business. Having said that, at 37% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On American National Insurance's P/E Ratio
American National Insurance has a P/E of 3.2. That's below the average in the US market, which is 12.6. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Given American National Insurance's P/E ratio has declined from 4.6 to 3.2 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than American National Insurance. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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