Essent Group (NYSE:ESNT) shareholders are no doubt pleased to see that the share price has bounced 38% in the last month alone, although it is still down 33% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 32% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
How Does Essent Group's P/E Ratio Compare To Its Peers?
Essent Group's P/E of 5.46 indicates relatively low sentiment towards the stock. The image below shows that Essent Group has a lower P/E than the average (10.6) P/E for companies in the mortgage industry.
Essent Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's great to see that Essent Group grew EPS by 19% in the last year. And it has bolstered its earnings per share by 36% per year over the last five years. This could arguably justify a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Essent Group's Debt Impact Its P/E Ratio?
Since Essent Group holds net cash of US$202m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Essent Group's P/E Ratio
Essent Group's P/E is 5.5 which is below average (14.8) in the US market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic. What is very clear is that the market has become less pessimistic about Essent Group over the last month, with the P/E ratio rising from 4.0 back then to 5.5 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
You might be able to find a better buy than Essent Group. 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).
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.