FBL Financial Group Inc (NYSE:FFG) is trading with a trailing P/E of 15.4x, which is lower than the industry average of 16.8x. While this makes FFG appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. See our latest analysis for FBL Financial Group
What you need to know about the P/E ratio
P/E is often used for relative valuation since earnings power is a chief 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 FFG
Price-Earnings Ratio = Price per share ÷ Earnings per share
FFG Price-Earnings Ratio = $69.25 ÷ $4.497 = 15.4x
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 preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to FFG, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 15.4x, FFG’s P/E is lower than its industry peers (16.8x). This implies that investors are undervaluing each dollar of FFG’s earnings. Therefore, according to this analysis, FFG is an under-priced stock.
Assumptions to be aware of
Before you jump to the conclusion that FFG is the perfect buying opportunity, it is important to realise that our conclusion rests on two assertions. The first is that our “similar companies” are actually similar to FFG, or else the difference in P/E might be a result of other factors. For example, if you compared lower risk firms with FFG, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing FFG to are fairly valued by the market. If this is violated, FFG’s P/E may be lower than its peers as they are actually overvalued by investors.
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.