This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Genworth Financial, Inc.’s (NYSE:GNW) P/E ratio could help you assess the value on offer. Based on the last twelve months, Genworth Financial’s P/E ratio is 3.13. That means that at current prices, buyers pay $3.13 for every $1 in trailing yearly profits.
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How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Genworth Financial:
P/E of 3.13 = $5.01 ÷ $1.6 (Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, Genworth Financial grew EPS by a whopping 125% in the last year. And earnings per share have improved by 23% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Genworth Financial’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Genworth Financial has a lower P/E than the average (14.3) in the insurance industry classification.
Genworth Financial’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 Genworth Financial, 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining 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.
Genworth Financial’s Balance Sheet
Genworth Financial has net debt worth 60% of its market capitalization. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Genworth Financial’s P/E Ratio
Genworth Financial trades on a P/E ratio of 3.1, which is below the US market average of 17.1. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold they key to an excellent investment decision.
But note: Genworth Financial may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
To help readers see past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.