This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in The Hanover Insurance Group Inc (NYSE:THG).
The Hanover Insurance Group Inc (NYSE:THG) is trading with a trailing P/E of 22.7x, which is higher than the industry average of 14.3x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. View out our latest analysis for Hanover Insurance Group
Demystifying the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for THG
Price-Earnings Ratio = Price per share ÷ Earnings per share
THG Price-Earnings Ratio = $120.44 ÷ $5.308 = 22.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as THG, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. THG’s P/E of 22.7x is higher than its industry peers (14.3x), which implies that each dollar of THG’s earnings is being overvalued by investors. As such, our analysis shows that THG represents an over-priced stock.
Assumptions to be aware of
However, before you rush out to sell your THG shares, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to THG, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with THG, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing THG to are fairly valued by the market. If this is violated, THG’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in THG. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for THG’s future growth? Take a look at our free research report of analyst consensus for THG’s outlook.
- Past Track Record: Has THG been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of THG’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.