This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use AUB Group Limited's (ASX:AUB) P/E ratio to inform your assessment of the investment opportunity. What is AUB Group's P/E ratio? Well, based on the last twelve months it is 17.96. That is equivalent to an earnings yield of about 5.6%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for AUB Group:
P/E of 17.96 = A$11.8 ÷ A$0.66 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does AUB Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (22.2) for companies in the insurance industry is higher than AUB Group's P/E.
AUB Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with AUB Group, it's quite possible it could surprise on the upside. 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
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
AUB Group saw earnings per share decrease by 5.4% last year. But it has grown its earnings per share by 5.3% per year over the last five years. And EPS is down 3.0% a year, over the last 3 years. So you wouldn't expect a very high P/E.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does AUB Group's Balance Sheet Tell Us?
AUB Group has net cash of AU$11m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On AUB Group's P/E Ratio
AUB Group's P/E is 18 which is above average (16.2) in its market. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than AUB Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org. 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.