This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Suncorp Group Limited's (ASX:SUN), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Suncorp Group has a P/E ratio of 15.91. That corresponds to an earnings yield of approximately 6.3%.
How Do I Calculate Suncorp Group's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Suncorp Group:
P/E of 15.91 = A$13.38 ÷ A$0.84 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Suncorp Group's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (18.9) for companies in the insurance industry is higher than Suncorp Group's P/E.
This suggests that market participants think Suncorp Group will underperform other companies in its industry. Since the market seems unimpressed with Suncorp Group, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that Suncorp Group grew EPS by 10% in the last year. And its annual EPS growth rate over 5 years is 7.4%. So one might expect an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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).
Is Debt Impacting Suncorp Group's P/E?
Suncorp Group has net debt worth a very significant 128% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On Suncorp Group's P/E Ratio
Suncorp Group has a P/E of 15.9. That's below the average in the AU market, which is 18.3. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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 Suncorp 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).
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.